Empowering Healthy Business: The Podcast for Small Business Owners

#4 - Best Practices for Closing Your Books Each Month

• Lindsay Jarosch • Episode 4

Share episode

Explore the process of closing your accounting books on a monthly basis, which is the prerequisite for being able to have the financial reporting you need to manage your business, with Lindsay Jarosch.

Link to download a sample Monthly Closing Checklist

Connect with Lindsay at:
https://www.linkedin.com/in/lindsay-jarosch-43481412/
To schedule a free consultation visit www.smartbooks.com

Sponsored by SmartBooks. To schedule a free consultation, visit smartbooks.com.

Thanks for listening!

Host Cal Wilder can be reached at:
cal@empoweringhealthybusiness.com
https://www.linkedin.com/in/calvinwilder/


Moderator:

Welcome to the Empowering Healthy Business Podcast, the podcast for small business owners. Your host, Cal Wilder has built and sold businesses of his own, and he has helped hundreds of other small businesses, whether it is improving sales, profitability and cash flow, building a sustainable, scalable and saleable business, reducing your stress level, achieving work life balance, or improving physical and emotional fitness. Cal and his guests are here to help you run a healthier business, and in turn, have a healthier life.

Cal Wilder:

Welcome small business owners. Today our conversation will focus around best practices for closing your books each month. In a nutshell, this means completing all the bookkeeping and accounting activities for the month so that you are able to produce whatever level of financial reporting you need to manage your business. Joining me today is Lindsay Jarosch. After starting her career in public accounting at KPMG, Lindsay transitioned to private accounting for a number of years including working as a controller. And then for the last five years, I have had the pleasure of working with Lindsay as she is now our director of cloud accounting as part books, where she is responsible, among other things for client accounting operations for all of our clients, which includes ensuring a successful monthly close for over 100 small businesses every single month. So between Lindsay and me, we aim to help you understand what goes into doing a complete closing of the books on a monthly basis, including, you know, do's and don'ts that we have learned over the last 15 years or so of closing the books for hundreds of small businesses at Spark books. So well welcome, Lindsay.

Lindsay Jarosch:

Thanks, Cal. Thanks for the opportunity to be on this podcast. It's a nice break from my day to day digging into financials and supporting our teams to close the books for all of our clients.

Cal Wilder:

Great. We're recording this on June 1. So we are just starting to heat up for the May monthly close right now. Right?

Lindsay Jarosch:

I'm super excited to take a break from it and share my intimate knowledge of the monthly closing process. So yeah, we're just getting started, beginning of a new month.

Cal Wilder:

Sometimes we start working with new clients, and they're not used to closing the books formally. And so we sometimes have a discussion about why is it important to close the books? So from your perspective, Lindsay, why do we want to do an official closing of the books versus just, you know, coding transactions that come in from bank feeds,

Lindsay Jarosch:

If you're trying to run a business and make decisions, it's it's really important to have accurate and timely financial statements and metrics, and those can only be be produced after a proper closing of the books.

Cal Wilder:

The title of this podcast includes closing the books each month, every month. So why is it important to close the books every month instead of just doing it at the end of the year? Or maybe once a quarter when you get around to it? And you know, are there businesses that don't really need to close the books every month? And

Lindsay Jarosch:

It's so important to have the data on hand to make timely decisions and pivot as needed. Sometimes it's make it or break decisions that have to happen real time. For example, do you have enough cash to make payroll in a few months? Or do you need to take out a loan? Is one revenue stream tanking? Are the margins shrinking? Are you are you pricing your product properly? Do you have the right staffing mix. So like all of those things, you don't want to wait to make changes as needed as you're running your business. So it's so important to have that data, sort of real time as we close the books every single month. There may be some businesses that don't need to do it every month, maybe you know, a small business or a business that has the same results month after month. Those you know, maybe you could get away with doing it quarterly or even kind of doing an annual sort of cleanup and look at it. But for businesses that are growing, or really have, you know, a lot of different things going on, it's so important to have that data monthly to look at and make really educated decisions based on the financial data.

Cal Wilder:

I think we can probably all agree there's a need for the books to be accurate. And generally, like you said, it's the best practice to close the books on a monthly basis. But let's talk a little bit more about timeliness and that timeline to close the books. Business owners want information as quickly as possible to understand how their businesses performing. But realistically, how long should it really take to close the books?

Lindsay Jarosch:

You know, a lot of times there's competing priorities, staff can't drop everything to focus 100% on the close. It takes time to get bills from certain vendors. Maybe invoicing customers at month end takes a little bit of time. Small businesses often use fractional solutions, like smart books that work to get the books closed for multiple clients. So realistically, you know, I think if you were to sit down and just focus 100%, on closing the books, you could probably get it done in two to three days. But really, in practice, especially at Smart books, we really try to get the books close by the 15th, through the 20th of the month, that gives us enough time to do our due diligence, get all of the supporting documentation, and really do what we need to do to dig in and close the books accurately. And get the books close by the 15th of the 20th, sometimes of the month.

Cal Wilder:

I usually think in terms of bottlenecks and critical paths to being able to get a process done in this case, get the books closed, so the financial reports can be run. And so we want to let's dig in a little bit about the actual tasks that going to closing the books to make this a little bit more real for the audience. So let's let's talk about, you know, the general progression of closing tasks and you know, what's common to all businesses? And then, you know, if they're different kinds of businesses that might have a more involved or complicated monthly close, you know, what drives that what does that look like?

Lindsay Jarosch:

Yeah, sure. So closing tax tasks are often interdependent, meaning some can't be completed until after another is completed. And then sometimes there's changes to one task that may require revising or related tasks. So for example, posting customer payments may need to be done before you reconcile a bank account. So often, when we're closing the books will go through and make sure we've posted everything that we see coming through the bank statements, everything that we see coming through the credit card statements, which has to be done before we can reconcile the bank accounts or even look at the AR Aging report. Sometimes we'll have to go back and, you know, fix where we may have applied to customer payment. And when we make those kinds of revisions, then we may have to re review the air aging report. So there's definitely a certain way that the tasks have to be done to make sure that we're capturing everything, especially you know, when we start out, one of the first things that we really tried to do is get all the bank statements and the credit card statements reconciled to make sure that we have everything in the books. But if there's something missing, or we do have to change something, sometimes we have to go back. So that's when you really see the concept of a critical path or maybe bottlenecks that we have to kind of wait for one thing to be done before we do another thing, we can't move on to the next step in the closing process until the the banks are reconciled, the credit cards are reconciled, and then we can we can move on to you know, the next steps. Also, you know, the customer invoicing process often takes take some time and some effort, depending on how many invoices have to go out or the complexity of the invoicing. There's some clients that we help with the invoicing process. And there's hundreds of invoices that have to go out. So obviously before the before we can close, all of the invoices have to be sent out to the customers created and sent out before we can close for that month. So that sometimes is is a bottleneck, we're waiting for the invoices to go out before we can move on with the closing the books process. And even posting vendor bills, you know, sometimes we're waiting for contractors to send in their bills, so that we know how much we need to reconcile recognizing the financials for that particular month. So well, you know, for some of them, we have to kind of bug when we know that we're really waiting for a big vendor to submit a bill, we may, you know, poke the client a little bit or even try to contact the vendor if need be to get that in. But again, that's something that we we need to have in the books before we can continue to close the books. Some of the other sort of things that we see when we're reconciling accounts, you know, we're trying to post everything that we see come through the bank feeds, there may be things that we don't know that we have to ask, you know, whoever is involved in closing the books. So there's sometimes a certain number of Uncategorized transactions that we'll have to resolve. So before we can really, you know, analyze the financial statements and look at the trends or run metrics, we'll have to figure out the uncategorized transactions by you know, asking and really get into the I don't know what those are so. So those are some of the things that we'll see that are really bottlenecks to closing the books and really some of those independent tasks that one thing has to be done before we can move on to the next thing.

Cal Wilder:

So if we're trying to get a business wants to get the books closed as fast as possible, after the end of the month, it seems like some of these activities really need to start and mostly get done during the previous month before the end of the month. So there's no reason to wait until after the month is done to go through and make sure all the bank and credit card transactions are posted, right, those can all be done during the previous month, and then anything that posts on the last day or two of the previous month, you can pick up after the end of the month. But it would seem like the the bank and credit card reconciliation process should largely be a formality at the end of the month. Unless I'm missing something. Is that right?

Lindsay Jarosch:

Yeah, the goal is always to minimize the bottleneck. So many tasks can be completed ahead of time, like you said, it's, it's really trying to remove anything in that short period of time after month end, when you're trying to close the books and bring it are completed earlier in the month if possible. For example, like payroll can be posted every time payroll is run. So on pay day, we can post a payroll. And that's not something that has to be done during during month end. Also, you know, just posting the customer and vendor payments, as they're made. Keeping up with the bank and credit card registers and updating them weekly with new postings. I mentioned the uncategorized transaction. So if there's anything unknown, we try to resolve them within the week, that we see them coming through the bank or the credit card to really minimize that back and forth during the short closed process. And that really can speed up the closed process and resolve some of those bottlenecks ahead of time.

Cal Wilder:

We keep mentioning, you know, reconciling accounts, specifically bank and credit card accounts. What does that really mean to reconcile a bank account?

Lindsay Jarosch:

Yeah, so reconciling a bank account. Some people you know, especially when we get new clients, they think it really just means coding what we see come through the bank feed in QuickBooks. QuickBooks does sometimes omit things or there are duplicates for whatever reason. So reconciling the bank account really means validating the balance on the in the general ledger in the financial statements and matching it to the bank statement, we really do ensure that the GL matches that bank statement. Sometimes there's a small timing difference if there's an outstanding check here, there. But really, the GL should match the bank statement. There is a nice feature in QuickBooks that it's the reconcile feature, which produces a reconciliation report when done. So that's something that we always look at when we're reviewing the books at the end of the month, we'll look and we'll double check that truly the balance in QuickBooks in the general ledger matches the bank statement that's really like paramount to ensuring the financial statements are accurate. So using that reconciliation feature within QuickBooks helps a lot. But really doing kind of that check to make sure that everything truly reconciles the balance and QuickBooks matches the bank statement puts us on the right track for closing the books accurately.

Cal Wilder:

So it would seem like at a minimum, you know, every every small business who's trying to close the books to get financial reporting, has to go through a few key steps, we'll talk about some of the more advanced closing activities in a minute, but it would seem like at a minimum, you gotta make sure you know, all the customer invoices for the month are produced, all the vendor bills have been received and posted. We posted payroll, we'll get into making sure payroll gets posted accurately because that's that's a challenge sometimes getting it posted accurately between wages and payroll taxes and employee deductions and, and all the line items that go into payroll reports. And then making sure we've posted and reconcile every bank account and every credit card account and resolve Uncategorized transactions, right and so if we can do all those things, we released completed the first tier of the monthly close. Absolutely. And so now that would cover businesses that are generally operating on more or less a cash basis, you know, they may be recognizing revenue based on the date of invoices or expenses based on the data bills, but they're not doing debits and credits accounting to accrue revenue or defer revenue or expenses of They're not doing extensive balance sheet schedules. They're just doing a basic closing on the books, you know, if you can do that month after month with consistent procedures, they'll have good consistent financial statements, you know, as a first tier to start using to make business decisions. But let's talk about businesses that have kind of made that leap more to full accrual accounting, and what goes into their monthly close. And I know we're starting to throw around some terms here. But let's talk a little bit what what is accrual accounting mean versus cash basis accounting?

Lindsay Jarosch:

Sure. So accrual accounting, is really used to tell a story about your financials cash basis is when you're really recognizing revenue and expenses based on when cash is received or sent out. So you'll see that the timing of recognizing those expenses in the financials is really based on the cash activity of payments and receipts. Accrual accounting is when revenue is recognized when goods and services are provided. And then expenses are recognized when they're incurred. So the timing changes a little bit, it doesn't matter when cash goes out the door. If a vendor, you know provides you that service within the month of May, then you're going to recognize that expense in the month of May regardless of if you pay it in June. It doesn't matter when the cash exchange hands it matters when, when the activity actually happened. Same thing with revenue is recognized when the goods or services are provided, regardless of when the customer pays their invoice. So even if they prepay it or pay it in the month after it's the service. If the services were provided in May, the net revenue was recognized in May. So when a company makes the leap to accrual accounting, there's a little bit more to do to close the books. So count mentioned, you know, at first we may reconcile the bank accounts and make sure we have all the vendor bills and all the invoices are sent out. But when a company decides to apply the concept of accrual accounting, we have sort of a tier two approach where we do more to close the books. So we start looking at kind of the timing of expenses. And there may be some prepaid expenses that we need to recognize. So we look to identify those new prepaid expenses, for example, an insurance policy, somebody a company may pay, you know,$10,000, in the month of May for an insurance policy for the next year. So that's pre paying that insurance policy for the next year. And we don't want to just post that $10,000, all in May, we want to post it equally over the next year. So we'll recognize it as a prepaid expense on the balance sheet. And we'll track that throughout the year and recognize the expense like 1/12 of the expense every month for the next 12 months. The same thing goes for accrued expenses, if maybe legal service was provided in the month of May, even if we have not received that bill, we know that service was provided. And we need to recognize an expense for that. So that would be an accrued expense. And often those are known expenses that, you know, we see coming that the client knows Oh, hey, you know, I have, you know, a legal bill for $5,000 coming, we haven't received it. But we do need to recognize that in the right month, the services were provided. Again, it doesn't matter when the cash changes hands. You know, the expense was incurred in that month. So a little bit more complex than just cash basis, but definitely paints a better picture when you're looking at the overall financials to really see what expenses relate to that particular month and what revenue relates to that particular month. So you can begin looking at trends that makes sense. Another thing that we look at is payroll. Sometimes payroll needs to be accrued into the month, so maybe employees don't get paid until the next month. But if they worked and incurred a payroll cost in that month, sometimes there's certain days that we have to accrue back, like maybe there's three days in May, that won't be that will be paid in part of the payroll at the beginning of June. But we need to recognize that Payroll Expense in the right month. So we'll kind of prorate the payroll and make sure that that expense is being recognized properly in May by booking a journal entry at month end.

Cal Wilder:

Right, because we because we run into situations where we're trying to close the books on a monthly basis, but many companies will have payroll on a bi weekly or weekly basis. So payroll is every two weeks or sometimes every single week and Although you can say there's four weeks that a month, four weeks is really 28 days, and most months have 30 or 31 days. And so you've got that extra two or three days of expense. And so if we don't go to the go to the trouble of doing payroll accruals, then we'll have a couple of months out of the year where we might have three paydays instead of two pay days, if it's a biweekly payroll, then your expenses look really out of whack those two months. And it's really hard to do good comparative analysis, if you've got some months with three pay days and some lunch with two days. And so to really try to make the the expenses be reported accurately on a monthly basis, we got to smooth that out. So we're recognizing 30 to 31 days of Payroll Expense every month, not 28 days, and some months and, you know, three or five paydays and other months.

Lindsay Jarosch:

And so we do that accrual accounting really to paint a more accurate reflection of business performance. So we're really just trying to align the costs to the right month, same thing with the revenue. Other things that we look for are are trying to book or depreciation expense, to depreciate, you know, generally on a straight line basis and fixed assets or capital purchases, also like pencil, if there's debt on the bar, and again, regardless of when that's paid, we still need to incur the interest expense in the right month. So those are some of the other things that we do when we're preparing financial statements and really closing the book, the basis for an accrual basis client.

Cal Wilder:

I think we're kind of seeing how these bottlenecks compound and can build on each other, right, because if we're trying to identify prepaid expenses, then we have to know what bills have been received or paid in the month first, so that we can then review them and identify which ones might have been for future benefits that need to get capitalized as a prepaid expense and then recognized over time in the future. And so that, you know, just kind of builds on itself. And so returning to this concept of the critical path and bottlenecks, I'll put a plug in for a particular book recommendation called the book is called The Goal by Eli Goldratt, which is an incredibly great book, it's relatively quick and easy to read. But it's all about understanding bottlenecks. And the critical path, which is that sequential series of bottlenecks from start to finish, where any one of those steps, if delayed will delay the whole process. And so there are certain things that are going to be critical path bottlenecks that have to get done in order to close the books. And then there may be some other things that need to get done. But you know, they might not be as time critical. So if we're trying to go through the closed process for an accrual basis business, where we have prepaid expenses, you know, making sure all the vendor bills have been posted is part of the critical path. Because until we do that, we cannot account for any prepaid expenses. At the same time of, you know, say payroll is paid semi monthly or monthly. So there's no need to do a payroll accrual, you know, we know we need to get the payroll account, the payroll booked and account for payroll for the month. But whether we do that, on the last day of the month are the second day of the following month, or the, you know, eighth day of the following month, you know, for trying to get the books closed by the 10th, or the 15th, doesn't really matter too much, you know, which particular day we put post payroll, because we could post it on the 15th, we could post it on the first, you know, as long as we get it posted a few days before we need to complete the close, it's gonna be fine. Whereas if we waited until, you know, the 10th data, you know, post all of our bills, now we're up against the wall, and we have no time to do a review and accounting for prepaid expenses. So really trying to identify and think strategically about each of the steps that go into the monthly closed process. Which ones are dependent upon earlier steps and kind of mapping out that critical path? Is it really important if we're trying to get the books closed? on a timely basis as fast as possible?

Lindsay Jarosch:

Yeah, to that point, I remember a client that had, you don't see it as much anymore because everything's electronic. But I remember a client, I had a whole stack of bills sitting on their desk, and they were like, you know, can you just close the books for me? Like, let's jump on the close. And I like, well, I need that stack of bills right there on your desk before I could do it. So definitely shows kind of that critical path and where bottlenecks can arise.

Cal Wilder:

So after we've gone through the process of closing the books, and we think they're closed, there's this whole quality assurance and quality control stage. And if you're a business that only has, you know, one bookkeeper or staff accountant, you may be in a bit of a bind, because it's hard you know, to do a quality control when there's only one person who both is no doing the work and then quality controlling the work. So there's a bit of a control or shortcoming there in the what you can possibly do to quality control the work if there's only one person involved in the process, but the best practice is to have some separation of duties, some review and quality control before we say the books are officially closed, and we can start to rely on the financial reporting to make decisions. So Lindsay, could you talk, talk us through some of the components of good quality control as part of the monthly close?

Lindsay Jarosch:

Yeah, absolutely. You know, I manage the monthly goals process for the teams at Smart books. And I really value the concept of trust, but verify, really, having a preparer and a reviewer two sets of eyes ensures consistency and accuracy. So the first thing that we generally have our team do is a self review, though, go through kind of the checklist, the monthly close checklists that we have in place, and really reviewed to make sure everything's complete. Everything has been done step by step, you know, all the reconciliations still reconcile all of the balance sheet accounts are supported. The income statement has been reviewed for trends or, you know, nothing's missing. And so they'll do a self review. And if anything arises, or questions come up, you know, they'll take, take care of that, before it goes to the next stage. The next stage in the QA process is a manager review. And the manager goes through the same process, really reviewing all of the steps up close from, you know, the top of the balance sheet to the bottom, and then going over to the p&l and looking at, like I said, trends or anything that's missing or looks unusual, you know, things that look out of place, or anything like that. And so once that's done, and once kind of all the steps of clothes are retraced, there's a preliminary review of the financial statements, and other reports are for reasonableness. Again, just walking through the p&l, really looking at trends, margins, ensuring everything looks reasonable, and there's nothing that kind of jumps out as far as things that look out of the ordinary. And then we move forward. And we say, okay, we run the financial statements, which we can talk about, and then we move forward and we close the books in QuickBooks, QuickBooks has a closed date that you can enter in, where no changes can be made after that. And that's really important, because you don't want anyone making changes to the financial statements after they're closed and verified, and accurate. From there.

Cal Wilder:

During that QA stage, I think it naturally leads into preparing and explaining the financial reports. Because you can, you know, you can go through the whole accounting closed process in which are closed, and then click some buttons to generate the basic financial statements, and send them out to the owner and say, here's, here's the financial statements for the month and year to date. But that's not particularly useful. It's better than nothing for sure. But when you're doing that QA, and you see things that look a little bit out of the ordinary, you're making notes or going back and verifying there wasn't actually a mistake, saying, you know, why was, you know, legal expense so high this month, or something went on what the rent and occupancy expense, and then we got an annual common area maintenance bill that comes in once a year that happened to hit that month that we had an accrued for. So you can kind of take notes about anything that looks a little bit out of the ordinary outside of the trendline in the Revenue and Expense sections of the financial statements on the income statement. And then you can kind of present a summary of the key variances, along with the financial statements to help the business owner and the executive team understand what happened,

Lindsay Jarosch:

The QA process is an excellent time to really kind of understand what's going on. A lot of times, there's a lot of back and forth, you know, if I do a review, whoever the accountant is that closed the books sometimes has to go back and ask a lot of questions or really dig into kind of the details of a certain transaction if it was material to the financials or really did cause any type of differences in when looking at trends and things like that. So it gives us a huge opportunity to really understand what's going on and tell that story. It is very helpful when we do present the financial statements at the end of the month to be able to have that narrative and explain kind of Some of the trends and really what went on in the business?

Cal Wilder:

Yeah, completely agree Lindsay, the financial statements tell a story. And in order to really define that story, we've got to look at all three of the main financial statements, which are the the income statement, aka Profit and Loss p&l, which is the one that most people pay attention to look at. And then there's the balance sheet, which is the list of assets and liabilities and net worth of the business. And then there's the cash flow statement that reconciles the income statement against actual changes of cash in the bank. And that last statement, the cash flow statement is the most challenging to look at and digest and understand and explain. But it's the key to help the business owner understand what's really driving changes in cash, because the p&l could look great. You could have a, you know, a $50,000 monthly profit on the income statement and think life is good. But you could look at your bank balance, and it might have gotten down$75,000. In the month, you're like what happened. My p&l says I made 50,000. But my bank statement says I lost $75,000. What happened? And so sometimes, we'll hear well just run the income statement on a cash basis because that's going to be more accurate, it's going to show me why my cash changed and what caused my cash to change. And that's not really true, because the income statement only includes items of revenue and expense, it does not include things like borrowing or repaying loans, owner contributions of capital, or hopefully larger distributions of capital when you distribute profits out of business. So the cash flow statement starts at the top with reported net profit from the income statement, the p&l, and then it looks at the different accounts on the balance sheet that actually contributed or consumed cash and lets you understand what really caused the bottom line change of cash in the bank. And so it's important that you have your bookkeeper or accountant really tell you the story about what's going on with all three of your financial statements, not just not just the income statement.

Lindsay Jarosch:

Yeah, that's spot on. I mean, the cash flow statement really paints a picture as to how the company's operations are running, where the money comes from, how the money's being spent. And that's why when we send the financial statements to the owner of the company, we do like to, you know, tell that story and have that narrative as to really what's going on with the business.

Cal Wilder:

So we've been going at this for about a half hour, you know, we've been talking mostly about what goes into closing the books. So there's obviously a lot that goes into closing the books. And we could certainly talk for another half hour if we wanted to. And we'll keep going on some other important topics. But it's clear that, you know, having a real system of being organized is key to being able to, you know, accurately and consistently and efficiently and timely, close the books each month. And so you mentioned it in passing a little bit the idea of a closing checklist. And I think I can't emphasize enough the importance of a closing checklist that I'll put in a plug for another book called The Checklist Manifesto, which is written by a surgeon, I think maybe even a neurosurgeon, brains brain surgeon. And it was a study of the use of checklists, in operating rooms and some other industries, where folks are generally pretty smart. And you think I'm a brain surgeon, I probably don't need a checklist to tell me to wash my hands and put on my gown and all these other basic things before I cut into somebody's brain. But they found that implementing basic checklists so that a consistent process was followed prior surgery dramatically reduced rates of infections and complications and preventable, preventable problems that result from surgery. And so I view it as accountants are pretty smart, but brain surgeons are probably smarter on average. And if a basic checklist can help brain surgeons be more effective in their job, then it ought to really help accountants and other folks who have to follow standardized processes to be that much more effective in their jobs as well. And so we will put a sample closing checklist link to a sample closing checklist in the show notes that you can download so you get a sense for you know, here's what a closing checklist looks like. You could modify it for your own business you can implement it you can have your accountant present it to you along with the financial statements on a monthly basis. So, even if you are dependent upon only one part Since doing your accounting, you can least have a little bit of a check and balance on what they're doing. If you're reviewing the checklist, making sure there's a checklist in place and reviewing the checklist as part of the reviewing the financial statement process and monthly basis.

Lindsay Jarosch:

Yeah, I mean, checklists support the methodical nature of closing the books. So it is helpful, we use checklists here at Smart books, and it's very helpful to be able to see where in the closed process you are, at any point in time as well to make sure everything's getting done.

Cal Wilder:

So we've talked a lot about kind of the do's the things that we should be doing as part of the monthly close. What are some of the pitfalls you've seen, with closing the books or taking on, you know, a new small business where you and your smart books team have come in to, you know, take over during the first month, they close and you've inherited some things? So, you know, what are some of the pitfalls and issues you've seen with closing the books that folks should be aware of and try to avoid doing?

Lindsay Jarosch:

So we've talked about it a lot, but the importance of bank reconciliations, and oftentimes, when we, you know, just jump into a set of financials for a new client, we'll see that the bank or the credit card, are not properly reconciled. There's uncleared transactions that somehow got into the books or things that double posted, where the bank does not even remotely agree sometimes to the bank statements. So that's the first one and the one that we try to correct right away, it's can't stress the importance of reconciling the banks and credit cards. Often, we'll also see other things that just haven't been coded or haven't been coded properly. So there's things just sitting in on like an Uncategorized account, QuickBooks has sort of a canned account called Ask my accountant. So we'll see things just sort of sitting hanging out there, which aren't helpful, because then you can't see where they really belong, you can't compare trends and expenses. So we'll try to rectify anything that's Uncategorized, or really, blatantly in the wrong spot. Whether it's, you know, negative items in the assets or liabilities, you know, we'll we'll really hone in on things that are clearly categorized incorrectly. A lot of times, we'll see issues in posting payroll payroll is a little bit tricky. Sometimes, you know, clients will just post the net amount that they see coming out of their bank account. But it's really important when posting payroll that the wages be posted to a wage account, and that employer taxes be reconciled as an expense, because that truly is an expense to the company, along with contributions for benefits, or employer funding of liability. So there's lots of lots of issues with payroll often that we see when we, you know, just start doing the bookkeeping and accounting for a new client. Also, as far as invoicing goes, sometimes the customer invoice dates are incorrect, prompting revenue recognition to be incorrect. So really getting the revenue in the right period, or at least dating the invoices in the right period, is is super important. And that goes along with vendor bills too, for expense recognition, really getting it getting the dates on the bills, correct so that they're recognized in the right period. And then there's like capitalization thresholds that we look for, like putting fixed assets on the books. Often, you know, if companies spend, you know, say a company buys a new building, we don't want that building to be expensed on the p&l all at once, we'll put it into fixed assets. So that we can depreciate it. That goes along with you know, we talked about prepaid expenses earlier in the, in the podcast, and it's so important to make sure that they're, you know, properly capitalized, if needed, a lot of times we'll use some kind of a threshold. So if it's over a certain amount, defined amount that we established to be consistent. A lot of times we'll do $2,000 Or sometimes $5,000. Anything over that amount needs to be capitalized, meaning it needs to go on the balance sheet and expensed in the correct time period instead of being expensed right in that current month. The other thing that we look for are, you know that we look at the chart of accounts. Sometimes things are posted in the parent account. So the header account, which is kind of a pet peeve, but it drives me a little bit crazy. It really shouldn't be put into kind of the child's account one of the sub accounts of the parent account so that you can really see what that expense relates to. And then sometimes there's very obvious things when you're looking at the income statement like rent, you'll see rent January, February and March but there'll be no rent in May and then and maybe some rent in June and a big rent expense in July. So really just figuring out like, Well, where did rent get posted in the missing month, things like that, like really making sure that all the expenses are being correctly recorded in every month to the consistent GL accounts. So that's just some of them, we see all kinds of things. But those are, those are probably the biggest offenders that we see when we're trying to close the books, especially for a client just coming in that really hasn't had a consistent, accurate closing process previously.

Cal Wilder:

You mentioned some sometimes some challenges around the dating of customer invoices for your own customers for revenue or the dating of vendor bills that you receive for expense recognition. And so on general practice that I've recommended kind of developing recommended over the years is what I call management accrual, you're not going to see it in any college accounting textbooks as an official accounting standard, but it's this intermediate step that gets you you know, 80% of the way toward GAAP, we will have to define GAAP in a minute but gets you kind of 80% of the way towards really good clean 100% accurate accrual accounting and gets, you know, 80 plus percent of the way there without having to do a lot more work than standard caspases accounting and a couple of the keys there are dating your customer invoices in the same month in which you delivered the goods and services. So if you did a bunch of work for a customer in May, and you bill in arrears at the end after the end of the month, so you actually send the invoices out your customers in early June, date, those invoices may 31. So that'll put all of your may efforts into revenue in the month of May. And then if you have some contractors or other service provider vendors who provided services or goods to you during the month of May have them date their invoices to you may 31. Or say the date is on June 2, and you get it on June 2, you can simply date the invoice and QuickBooks on May 31. And you're off by a couple of days technically versus what's printed on the invoice but it just doesn't matter. And it's a lot easier. Having the customer invoice or the vendor bill just dated in the right month and having to open up a spreadsheet and do a balance sheet schedule and worry about accruals and reversals and quality controlling a spreadsheet and human errors in the spreadsheet. We get to date, the invoices and the bills in the same month in which goods and services are delivered. That gets you almost all the way yes, there are some finer points and it's not 100% GAAP, but it gets you pretty darn close. And if you can have your people paid semi monthly instead of every two weeks, you don't have to worry about any payroll accruals or any three payday or five payday months. It just recognizes one month's worth of payroll costs based on the natural payroll frequency. So there are a few things like that, that get you most of the way toward good clean accrual basis accounting books without having to do a whole lot of accounting work. So I mentioned GAAP, what does that stand for? What does that mean, Lindsay? And it really how relevant is that to small businesses?

Lindsay Jarosch:

Sure. So GAAP stands for Generally Accepted Accounting Principles. And it's really a framework of rules on how you should appropriately and properly account for all of your transactions. It's relevant to small businesses when an audit is needed, or you know, maybe the business is rapidly growing and you're looking to sell or, or truly grow into potentially a public company at some point in time. But often for small businesses. Using the gap framework for every single transaction is is cost prohibitive, and just really not necessary. Cal described the concept of management accrual where where, you know, dating bid, the vendor bills in the month services are delivered, capitalizing large purchases over say a threshold of $5,000, things like that. It really makes it a lot easier for small businesses and really take so much less time to kind of take some of those those shortcuts even for very small business on a cash basis, which isn't, isn't GAAP, GAAP really follows the accruals standards. But some sometimes it's just not not needed. You can get a good picture of your business without following every single, you know, to the tee rule that gap outlines so you know, using the management accrual methodology gets you there allows you to make decisions as needed and really does and take all the time and effort needed to really apply GAAP in every single instance. And you'll still get fantastic financials that will allow you to run and grow your business or really do whatever whatever it is that is the kind of ultimate objective for your business without really spending the time and money to follow GAAP in, in every sense.

Cal Wilder:

My perspective on GAAP, unless it's required by outside investors or lenders, or there's an anticipated Action event that's gonna require a full GAAP audit anytime soon in the next few years, I would much rather my team at Smart books put their marginal extra time into analyzing and helping clients plan and manage their the financial side of their business and help them make business decisions that improve profitability and increased ultimately the value of their business. I'd much rather we put our marginal time into those activities than fine tuning GAAP financial statements in the past, right. When we're accountants we, we tend to report what happened in the past. And you get to a certain point where there's diminishing returns of trying to report slightly more accurately according to GAAP principles what happened in the past, I'd much rather we start to help plan and predict the future, which will help business owners manage the business a lot more effectively than, you know, trying to go from 90% accurate to 99% accurate, if it involves doubling the accounting cost. One other thing I wanted to ask you more specifically about Lindsey is payroll accounting. I know it can be challenging. A lot goes into payroll accounting, often you're posting it by journal entry with debits and credits and having to keep that straight. And if the wages are reported on the income statement, that goes on to the tax return don't match the payroll tax return to the income tax return wage amount doesn't match the payroll tax return wage amount, it can be a red flag, it's certainly something that tax preparers going to ask about to try to fix it after the end of the year. So can you explain a little bit more what goes into proper payroll accounting and in what you need to be aware of?

Lindsay Jarosch:

Sure. I mentioned earlier, often we see, you know, when we take on a new client, the previous bookkeeper or whoever was doing the bookkeeping posts, the payroll just says, you know, a Payroll Expense with whatever they see coming out of the bank, which come tax time, is really not not going to work. So what we really look for is posting gross wages as an expense. So that's number one, that's an expense to the company, gross wages need to be posted as a Payroll Expense, then we'll look at taxes. So on the payroll report, you'll see the employee taxes, the taxes that the employee pays and the employer taxes. And what we're really after is the employer tax expense, that's the expense to the company that needs to be recorded in the financial. So we'll we'll find sometimes it's a little bit tricky. Sometimes you have to run different reports to really get that separation between employee versus employer tax expense. But we'll find that employer tax number and post that as an expense. And then we'll look at some of the other things. So sometimes, you know, certain benefits, there's contributions from the employee that needs to go against the premiums that the company pays. So those will often be recorded as to the expense account as sort of an offsetting expense to the premium that's ultimately paid by the company. So we'll look for some of the benefit expenses that maybe need to be posted a little bit differently. Some of the other expenses that maybe are expenses to the company or for retirement accounts. So there's often like 401k match that will need to be recorded as an expense. And sometimes those are not paid by the payroll company. They're paid separately by the company to the 401k company. So often we'll have to put the liability for those because there'll be paid at some point in the future. So there is a lot of complexity that goes into properly posting a payroll when it when it comes through a lot more complicated than just posting kind of the net amount that comes out of the bank. And we'll verify this by doing a quarterly payroll reconciliation. So every quarter we'll pull down either the wage register or the quarterly payroll, tax filings and we'll tie that wages and the taxes to whatever is in QuickBooks to ensure that, you know, nothing was missed. No payrolls are missed, everything's in there, and it really ties out. And then at the end of the year, we provide the quarterly payroll reconciliations to the tax accountant, which is extremely helpful in ensuring that nothing was missed, and all of the payroll items are properly recorded in the financial statements.

Cal Wilder:

Lindsay, if we recap this discussion, in a few bullet points, I think we've established the monthly close is a very methodical structured process, a lot can go into it depending on how far down the path of accrual accounting the business needs to go. You know, it is possible to kind of do it yourself to a certain extent, especially with, you know, written standard operating procedures and closing checklists. But at some point, it's going to need to be managed by a professional accountant who can determine the right accounting policies and how to implement them with an eye toward being able to produce reporting that is valuable to the business. And I guess ultimately, as a small business owner trying to assess, you know, how well their monthly closes, working and how much confidence they should have in it, do they need to upgrade it? I think ultimately, the question is whether the business owner is confident that they're getting accurate and timely reporting that they can use to help manage the business. So Lindsay, thank you so much for taking the time to put together this episode with me. I know what we do in future episodes and other topics related to small business accounting. And I know we've we've provided definitely some takeaway value for listeners to help assess and upgrade what goes into their monthly close and we've got a sample of monthly closing checklist template that's available for download, but we'll link to that in the show notes. And so listeners if you'd like to follow up with Lindsay and me and our team at Smart books here to explore how smart folks might be able to help you with your business and its own monthly close and financial reporting needs or any other bookkeeping and accounting and reporting needs. Please visit us at smartbooks.com. Right on the homepage, there's a link to schedule a free consultation with us. Reference show notes and find other episodes on EmpoweringHealthyBusiness.com. If you would like to have a one on one discussion with me, or possibly engaged smart book to help with your business, you can reach me at Cal "C-A-L" at empoweringhealthybusiness.com or message me on LinkedIn where I am easy to find. Until next time, this is Empowering Healthy Business, the podcast for small business owners signing off

People on this episode

Head Shot

Calvin Wilder

Host