How to Close the Books: 8 Steps for Small Business Owners
“The books” are a business’s revenue, expense and income summary reports. A business owner can close their books by zeroing out their income and expense accounts and then plugging net profit (or loss) into the balance sheet.
Some accounting software will automatically close your income and expense accounts at year end before adding your net profit (or loss) to your retained earnings account. Accounting software may create an automatic closing date as well as a password so transactions from before the closing date can’t be changed.
In this article, we’ll cover the following steps:
- Transfer Journal Entries to the General Ledger
- Sum the General Ledger Accounts
- Make a Preliminary Trial Balance
- Enter Adjusting Journal Entries
- Make an Adjusted Trial Balance
- Generate Financial Statements
- Enter Closing Entries
- Generate a Final Trial Balance
8 Steps to Close the Books
Closing the books is a process usually performed by an accountant. But a small business owner can take on the task by using accounting software. The task is easier the smaller a company is as there will be fewer monthly transactions. Accounting software may automate some of the below steps.
Still, even if you ask your accountant to close your books for you, it’s important to understand the basic steps involved so you know what to expect from him or her. This article covers closing books that use double-entry bookkeeping since that’s the most common system used by small businesses.
1. Transfer Journal Entries to the General Ledger
The journal is the first point of entry of all transactions. Journal entries are transferred to the general ledger when they’re posted to an account, such as accounts receivable.
To close the books, post the account totals from your cash payments and your sales and cash receipts journal to the appropriate general ledger account. Cash payments (also known as “cash disbursements”) actually include any payments made by cash, check or electronic fund transfer. The same is true of your cash receipts journal, though this journal tracks inflow, not outflow, of funds.
Most small companies close their books monthly, though some only do so at year end. That means you need to choose what entries you want to include. For example, you could choose all entries in 2017, or it could be for the month of January 2017 only.
2. Sum the General Ledger Accounts
Add up all the transactions in each general ledger account. For example, add up all entries in accounts receivable. This gives you a preliminary ending balance for each account.
3. Make a Preliminary Trial Balance
Sum all of the preliminary ending balances from the last step to make a trial balance. A trial balance is a report that adds up all the credits and debits in your business. You want your total credits to be the same number as your total debits—if they aren’t, go back and check your work. It the credits and debits are equal, your accounts balance and you’re ready to go to the next step.
4. Enter Adjusting Journal Entries
Adjusting entries record items that aren’t noted in daily transactions. These items include accumulation (known as “accrual” in accounting) of real estate taxes or accrual of depreciation and need to be recorded in order to close the books. Adjusting items are made in the general journal.
5. Make an Adjusted Trial Balance
Sum your general ledger accounts again to take into account the adjusted entries from the last step and then add them all together to make a new trial balance, making sure your debits and credits are again equal. If they aren’t the same, go back and check your work.
6. Generate Financial Statements
If the total debits and credits in your trial balance are the same, you’re ready to produce a balance sheet and income statement (also known as a “profit and loss report” or “P&L”). These reports can be generated automatically in your accounting software. They offer an overview of a business’s financial position at the end of the applicable accounting period, whether that’s the previous month or year.
7. Enter Closing Entries
Zero out your revenue and expense accounts by using journal entries called “closing entries.” Closing entries transfer the balances of these temporary accounts to permanent accounts. For example, the revenue account is emptied into the retained earnings account.
8. Generate a Final Trial Balance
The final trial balance report will only have balance sheet accounts since you zeroed out your revenue and expense accounts in the last step. Again, the total debits and credits must match. If they do, your general ledger account balances are correct and you’re all set for the next accounting period!
Common Questions Related to “How To Close Books”:
- What Does It Mean to Close the Books?
- What Is the Purpose of the Closing Process?
- What Accounts Are Affected by Closing Entries?
What Does It Mean to Close the Books?
“The books” are a company’s record of financial transactions. The records are used to generate reports that tell an owner how much money is flowing in and out of their business.
Closing the books means that these reports are finalized. These finalized reports show a business’s financial position over a certain accounting period—whether a month or an entire year.
What Is the Purpose of the Closing Process?
The purpose of the closing process is to make sure income or expenses from a previous accounting period don’t carry over to the current accounting period, which would make its figures inaccurate.
Closing the books annually lets businesses draw up financial statements that give owners insights into their business’s financial health. Small businesses usually generate statements like a balance sheet and income statement at year-end to look at the financial state of their business as they prepare for the upcoming year.
Small business owners need to close their books at year end in order to properly file their income tax returns. Closing the books properly also ensures that your bookkeeping system is in good order and is generating accurate numbers to include in your tax return.
Closing the books on a monthly basis is also a common practice. This process makes it easier to do monthly tasks like reconciling your bank statement, sending sales tax reports to the state, paying your suppliers and generating customer statements.
What Accounts Are Affected by Closing Entries?
The following accounts are affected by closing entries:
- Revenue accounts
- Expense accounts
- Dividend accounts
The above accounts are temporary or “nominal” accounts that are zeroed out when closing entries are added to an accounting system. Closing entries reset these accounts so they don’t affect the next accounting period. The accounts aren’t erased; instead their balances are transferred to retained earnings, a permanent account.
Occasionally, revenue and expenses are transferred to an intermediate account called an income summary. Dividends are always transferred directly to retained earnings.