Finally, after a long and hard month, you are closing your books and preparing your financial statements. Once they are complete, you walk to the printer, grab your financial statements, and take them to your desk. As with each previous month, you comb through each number and percentage in order to do one thing: paint a picture of your business and move on to decision making.
Whether you choose to make a change or keep the status quo, you make these decisions based on your financial statements, which means they must be accurate. However, we have often find closing our books can be a hectic and burdensome process. As a business owner or operator, our days are often so busy we have little time to focus on making sure our closing process is correct. This lack of time can often lead to mistakes, which can drastically affect your financial statements and affect the decisions you make.
Here is a checklist you can use to ensure each month end is quick and accurate:
1. Adjusting for Inventory
There is almost nothing more important than adjusting for your change in inventory. As we all know, inventory is directly related to cost of goods sold, which is directly related to your net profit. Whether you physically count inventory once a month (something I am a major proponent of) or rely on your inventory management system, a business operator must adjust his or her cost of goods sold depending on their change in inventory. If your inventory falls by $10,000 then you must adjust this by increasing your cost of goods sold and decreasing your inventory. One makes this adjustment because the business has sold $10,000 worth of products which were originally in inventory. Those goods are no longer in your inventory, and the business has received revenue for those goods, meaning one must match the cost of those goods with the revenue received. If the business does not match the revenue and the cost of the goods sold, the business would ultimately be overstating its profit.
2. Completeness Check
The next step is to check for missing credits or invoices from suppliers. While these invoices or credits may eventually come to the surface, big invoices and credits can cause drastic swings in your net profit as well as your gross profit and net profit margin. The last thing a business owner or operator wants is to spend valuable time analyzing numbers and making decisions based on faulty numbers. While you do not necessarily need to hunt down every single invoice, we would recommend you at least talk to your employees or vendors to make sure there are not large invoices which have been missed or not sent into the office.
3. Accruing for Accuracy
Following the invoice check, we recommend you begin to make entries for items occurring during the period, which you may not have billed for or have been billed for but the expense applies to multiple periods. Accountants call these items accruals and deferrals. A simple example can be utilities, but these types of entries can become more complex as you incorporate items such as payroll. As we all know, when month end rolls around, the business has used electricity for an entire month. However, you will not receive your utility bill until the middle of next month, and no one wants to wait until then to begin their financial statements. Because of this predicament, we typically say you should accrue an expense. In short, you debit an expense account and credit accrued liabilities since the cash has not been dispersed, but we owe the liability because we have used the electricity. Your main goal here is to estimate the expenses you have incurred so you have a true picture of your net profit for the month. If you did not accrue anything, your operation’s financial statements would not accurately reflect your month’s operations.
4. Deferrals for the Future
The opposite of an accrual is a deferral. A deferral is when you are postponing recognition of an expense or revenue. A basic example of a deferral is an insurance premium. Some businesses will pay their insurance premium in six-month increments. Therefore, the cash is leaving the bank while the actual expense applies to a six month period. In order to accurately reflect the insurance being related to the next six months, a business would make one of two decisions depending on the original entry. If the business had originally charged the amount to expense, the business would defer the expense by crediting the expense and debiting a prepaid expense account for the five months which the expense does not apply. On the other hand, if the bill total had been put into prepaid expense the business would debit the expense account and credit the prepaid expense prorated for one month of the total bill.
Accounting is often referred to as the language of business and for good reason. Accounting pulls together vast amounts of information to give a business owner/operator insights into their business. Without the proper accounting processes and procedures, the reports generated by the accounting system could be incorrect. These reports are the prime driver in business decisions. There is no question as to whether these reports can be right, they must be right.