Read This Post to Me
“Closing the books” is a phrase that invokes a sense of discomfort—even dread—in business owners. As Jen Nord explains, it really shouldn’t. Don’t get hung up on the jargon associated with the accounting procedures (e.g. trial balances and adjusting journal entries). Instead, focus on the big picture.
Closing the books simply describes an accounting discipline that helps ensure that your financial statements are up-to-date and accurately reflect the condition of your business. Closing your books monthly is analogous to good hygiene. It’s kind of a pain in the short-run but helps ensure a healthy life.
Don’t Sweat the Jargon
In accounting terms, closing the books describes the process of reducing temporary income statement journal entries to zero and transferring the net amounts to the equity account on the balance sheet. Much of the bewildering language associated with closing the books reflects the old-school world of journals and ledgers. These still exist under the hood of modern accounting systems, but many entries are now handled automatically.
In more general business terms, the closing process entails tasks such as the following:
- Reconciling your bank account statements
- Making sure invoices are sent to customers in a timely fashion
- Reconciling the transaction information in your point-of-sale and e-commerce shopping cart systems with your financial accounting system
- Reviewing your inventory counts and values
- Updating and reconciling other balance sheet accounts such as loans payable
Read the Transcript
Jen, one of the mysteries of business is the accounting ritual known as “closing the books.” Help us demystify that. What does closing the books mean?
I feel like the term, “closing the books,” gets tossed around in the business world, and there’s instantly stress associated with it. I was scrolling through my Instagram feed the other day and a friend of mine, who’s a new business owner, posted a picture of a desk full of receipts and a caption that read, “Closing the books for the new year. Wish me luck.” And my guess is she wasn’t looking forward to the process or even the end result. And just like your question, she probably has no idea what closing the books actually means. And it’s really quite simple if, and that’s a big if, you stay on top of things.
The definition of closing the books really means to zero out the accounting period—that’s whether it’s a month, the quarter, a year, or the century—for income and expense accounts and just start fresh for the new period. So you see, in the very basics of accounting, the profit and loss statement reports the income and expenses over a period of time. And part of moving forward to the next period of time is to close a chapter and to start with the next one fresh. So that’s really the basics of closing the books.
Why is it important? Why do we need to close the books?
I think some small business owners live in the day-to-day and live by gut instincts. They might tell you that they’ve never closed the books and that it isn’t important, but a fresh start to any period is important. Closing the books allows a business owner to look back over the previous period and review their financial performance. It gives them their actual data to review versus just going off those gut instincts.
For instance, let’s pretend you’re a small business owner who makes coffee mugs. In your gut, you think you’ve been selling your coffee mugs like crazy and your inventory turnover has doubled. Because you’ve felt busier—you’re filling more orders, the phone is ringing off the hook, and you feel like you’re making multiple trips to the post office to ship out your product—it’s had to increase, right?
When you actually close the books, make your final inventory counts, and review your financial performance for the month, you may actually realize that your turnover hasn’t increased. Instead, you’re busier because you’ve been completing smaller sales orders.
So that’s just one example of how closing the books can actually show you the actual financial performance versus what your gut is telling you. Then you can make more educated financial decisions regarding how to move forward in your business.
For some, closing the books evokes a sense of dread. Why is that, and why shouldn’t we dread it?
I think with most people who have a sense of dread with the accounting and bookkeeping function in their business, it’s not their forte. It’s just like me being an accountant. If you ask me to manage a social media page for a retail business, I would dread every second of it because it’s not my forte. In today’s world, that might be what I need to do to bring in customers. Closing the books is one step that a business owner needs to do to get accurate financial information, They need to do it to make educated financial decisions about their business.
Let’s say that I’ve bought into the logic of closing the books. What are my options? How do I get it done?
Well, the first option is to outsource it. You can find someone who can do it in a quarter of the time that you can if you’re dreading it, and it doesn’t have to be a CPA firm. It could be a qualified bookkeeper. It could be a CPA for hire, or it could be a retired business guru who knows a thing or two about closing the books and wants to stay relevant in the business world. Your second option could be to learn how to do it yourself. The first time will be rough, guaranteed. But it’s kind of like riding a bike. The first time is never easy. After that, it gets easier every time, and it soon will become second nature.
With closing the books, there’s a lot of repetitiveness. And so you’re going to go through a similar process every period that you close. There’ll be a few weird things that’ll come up as you go. But before you know it, it’s going to become second nature, and it’ll be pretty easy.
What does closing the books entail?
Some are tasks you might already do as a business owner such as reconciling your bank and credit card accounts and making sure that you send out your invoices to your customers on a timely basis. Those are things that, hopefully, you’re already doing. Another thing that you’re going to want to do is to reconcile your accounting system to your point-of-sale system at the end of each period. You might find that those two systems already talk to each other, and it’s as simple as making sure that they’re speaking the same language. As I alluded to before, it could be checking your inventory. This might be a formal inventory count, or it might just be a review of your inventory for spoiled, obsolete, and non-existing items and then making sure that those counts are put into your accounting system.
Once you review those big-hitter items, you’ll want to review the rest of your balance sheet. That’s your asset, liability, and equity accounts. In looking at those accounts, you’ll want to reconcile those to supporting documents. For example, if you have a loan, you’d reconcile it to a supporting amortization schedule. Finally, once you have all of your balance sheet items reconciled, you post your revenue and expense accounts to your balance sheet, so you can start the next period with a fresh set of books.
One thing to note with this entire process is that not all accounting software is created equal. Each software system has its own way of helping you close the books. So before you start, look into the software that you use and see what it recommends regarding closing the books. Your software might complete some of the processes automatically for you.
This all seems like good accounting hygiene. But what is the payoff from a business perspective?
I think the payoff is that, over time, you’re going to have consistent reports that you can use to make educated financial decisions for your business. Whether you do it yourself or you outsource it, closing your books doesn’t have to be dreadful, and you will see the benefits over time. You might not feel like you see benefits after the first month or even the first three months. But over time, as you look back, you will see that you’ll have consistency in the numbers that you can then use for comparison purposes to make educated financial decisions.
Create a Closing Process and Stick to It
As Jen notes, you don’t need a CPA to close your books, though it might not hurt to get a CPA’s help to develop a closing checklist. With practice, you can learn to close your own books. Most of you, though, will probably want the help of a qualified bookkeeper or accountant—especially if your business generates a lot of transactional data each month. Getting help to tie together information from multiple sources can make the closing process less daunting and time-consuming.
How you do closing is less important than the fact that you close your books regularly and consistently. Putting off the task usually means that small errors can accumulate into a big hairball that can be really tough to untangle. The timeliness and accuracy of your financial statements are the usual victims. If you want to augment your business intuition with facts, closing the books is a process to embrace not dread.