For small business owners, the end of the year means sealing up loose ends financially. This process is known as “closing the books” in accounting. Ensuring every dollar attributed to one year is recorded accurately is crucial to avoid making the new year inaccurate.
The best accounting software, like QuickBooks Online, can simplify this task. However, there are many steps to take to ensure a clean slate and a successful tax season. Let’s analyze this process in detail.
Why close the books?
Closing your accounting books at the end of the year is essential for several reasons:
- Accuracy: Ensures that all financial transactions are correctly recorded, minimizing errors and discrepancies.
- Compliance: Helps meet tax and regulatory requirements by providing a clear and accurate financial picture.
- Financial analysis: Allows you to assess the financial health of your business, identify trends and make informed decisions.
- Clean start: Prepares your books for the new year, preventing past transactions from interfering with current accounting.
If you don’t thoroughly account for a year’s finances, it can start a chain reaction of erroneous figures moving forward. This problem can lead to inaccurate tax returns, unreimbursed expenses and a false conclusion of profit or loss.
10 steps to close the books
Hiring a certified accountant can feel expensive for smaller businesses. But even without a professional accountant on standby, you can follow these steps to close your books effectively.
1. Reconcile your bank accounts
Reconciliation ensures your bank statements match your accounting records, highlighting any discrepancies that need to be addressed.
How to do it
- Collect all business bank and credit card statements.
- Match each transaction in your accounting records with your bank statements.
- Investigate and correct any differences.
- Document the reconciliation process for future reference.
2. Review your accounts receivable and payable
Ensuring that all customer invoices and supplier bills are correctly recorded and up-to-date helps maintain accurate financial records.
How to do it
- Review your open invoices to see which are due before the year ends.
- Send reminders for overdue invoices and write off any bad debts.
- Ensure all bills due before the new year are paid and recorded.
3. Update inventory records
Accurate inventory records are crucial to determining the cost of goods sold and the overall financial health. It also helps calculate shrinkage so you can take action to prevent theft and waste.
How to do it
- Conduct a physical inventory count to verify your stock levels.
- Identify items with the highest losses and develop strategies to reduce these figures.
- Determine if insurance coverage or tax strategies can help mitigate the effects of inventory loss.
4. Record depreciation and amortization
Recording depreciation and amortization accurately reflects the value of your assets over time and impacts your financial statements.
How to do it
- Consult with your accountant or IRS documentation to determine the appropriate depreciation method.
- Log items, like real estate and inventory, that are subject to depreciation.
- Gather receipts and sales records to determine the current value compared to the original purchase price.
SEE: Computer Hardware Depreciation Calculator (TechRepublic Premium)
5. Accrue expenses and revenues
Accrual accounting requires that expenses and revenues be recorded when they are incurred, not when cash changes hands. So, you’ll need to track what costs and invoices have happened during the year, even if you have yet to receive or send payments for them.
How to do it
- Identify any expenses incurred but not yet paid and revenues earned but not yet received.
- Once payment occurs, it should be retroactively applied to the current year’s tabs.
- Mistakenly attributing a payment to the new year will give the false impression of more profit or loss for that year.
6. Generate financial statements
Financial statements provide a comprehensive view of your business’s financial performance and are essential for tax preparation and strategic planning.
How to do it
- Software like QuickBooks Online can automatically generate reports in a snap.
- Alternatively, you can manually “follow the money” and add up each transaction.
- Double-entry accounting is crucial to creating reports that leave a clear path of where every cent went.
7. Back up your financial data
Ensuring your financial data is backed up protects against data loss and facilitates future reference. This easy recovery prevents problems if the IRS requests an examination or if you work with an accountant.
How to do it
- Make copies of all paperwork. This process may get pricey with ink and paper, but it’s worth it in the event of an audit or other issues.
- Back up digital files to a cloud storage service like Google Drive.
- Take photos or scans of receipts and store them along with other documents.
8. Review tax documents
Reviewing and preparing your tax documents ensures you comply with IRS regulations and avoid potential penalties. You should also study new regulations that go into effect on January 1.
How to do it
- Collect all necessary tax documents, including W-2s, 1099s and receipts for deductible expenses.
- Review the IRS website for announcements on new laws and policies.
- Consult with your accountant or tax filing software to finalize your return.
9. Consult with your accountant
A certified accountant can provide expert advice, ensure compliance with tax laws and help identify potential issues. If you don’t already have such a professional, consider making a shortlist of candidates to consider hiring as your business grows.
How to do it
- Schedule a meeting with your accountant to review your financial statements and tax documents.
- Discuss any discrepancies or concerns you may have.
- Make any recommended adjustments before finalizing your books.
10. Plan for the next year
Planning for the coming year helps clarify financial goals and expectations. This foresight makes it easy to forecast how long it will take to reach your desired stage of growth.
How to do it
- Review your financial performance and set goals for the coming year.
- Use insights from your financial statements to make informed business decisions.
- Update your budget and financial projections via software like QuickBooks Online.
The takeaway
Closing your accounting books at the end of the year is a critical task for small business owners. It ensures accuracy, compliance and a clear financial picture, especially as tax season looms. Utilizing accounting software simplifies this process by eliminating manual work, like tallying up transactions.