6. Purchase Raw Materials
what happens when you buy the raw materials used to create your company's product? You receive the goods, and you either pay cash for the goods or obligate the company for future payment. Both transactions require these accounting entries:
· Increase raw materials inventory
· Decrease cash (if you paid on the spot)
· Increase accounts payable (if you didn't)
At this point, we've covered the first two steps of the business cycle listed above.
7. Begin the Manufacturing Process
when we use raw materials to make our product, the accounting system transfers the inventory from raw materials to an intermediate stage called work in process (WIP for short). This transaction explains the third and fourth steps of the business cycle.
8. Pay Suppliers
sometime during the production process we must pay our suppliers if we bought the raw materials on credit. The accounting entry for this transaction does two things:
· Reduces accounts payable
· Reduces cash
9. Complete the Manufacturing Process
At last; we have completed our manufacturing process. Now we can move the product from the work in process inventory to the finished goods inventory. This transaction particularly interests the sales staff, since it means that the product is now available for sale, and that's what generates their commissions. The entries into the accounting system that record this event go like this:
· Reduce work in process inventory
· Increase finished goods inventory
We've now completed the sixth and seventh steps of the business cycle.
10. Sell the Product
At last we're ready to make a sale. If it's a credit sale, our accounting system must record these transactions:
· Reduction in finished goods inventory
· Increase in accounts receivable
· Increase in sales revenue
If this was a cash sale, replace the increase in receivables with an increase in cash. We just finished the eighth step of the business cycle.
11. Collect the Receivable
the final stage of the business cycle is conversion of the receivable (which is an asset) into spendable cash. When the customer pays, the accounting system records a decrease in receivables and an increase in cash.
This ends the business cycle and the various accounting transactions involved. The accounting system we're setting up will cover every one of these transactions.