How to Do the Month End Close Process

The month-end close process is a sequence of accounting activities performed at the end of each fiscal month. It involves reviewing, reconciling, and finalizing all financial transactions for the period. This ensures accuracy and completeness of a business’s financial records.

The close provides a reliable snapshot of the company’s financial health. Accurate financial reporting supports informed decision-making by management, investors, and other stakeholders. It also helps businesses comply with regulatory standards and prepare for tax obligations. Closing the books regularly allows companies to identify trends, track performance, and address financial issues promptly.

Preparing Your Books for the Close

Preparation for the month-end close ensures financial data is complete and accurate. This involves gathering all source documents from the preceding month, including invoices, receipts, and bank statements. These records ensure transactions are captured and properly categorized.

A primary step in preparing for the close is performing bank and credit card reconciliations. This involves comparing the company’s internal cash ledger with statements from financial institutions. Discrepancies often arise from outstanding checks, deposits in transit, or unrecorded transactions like bank service charges or interest. These require identification and adjustment.

Verifying accounts receivable (AR) and accounts payable (AP) balances is next. For AR, confirm all customer invoices are recorded and payments accurately applied. Review for unapplied payments or credits that might distort customer balances. For AP, ensure all vendor bills for the period are entered and payments correctly posted.

For businesses managing physical goods, inventory verification is important. Compare inventory records to the actual physical count of goods on hand. Any differences must be noted, as these discrepancies require formal adjustments later. This ensures the balance sheet accurately reflects inventory’s true value.

Reviewing general ledger accounts for unusual or miscategorized transactions completes preparation. Scrutinize each account for entries that appear out of place, are unusually large or small, or seem incorrectly classified. Correcting these errors before adjusting entries helps maintain data integrity and provides a cleaner foundation for subsequent steps.

Making Adjusting Entries

After preparation, adjusting entries are made. These journal entries ensure financial statements adhere to accrual accounting principles. Adjustments match revenues with expenses incurred within the correct accounting period, regardless of when cash changes hands.

Accruals represent revenues earned but not yet received, or expenses incurred but not yet paid. Accrued salaries for employees working at month-end require an adjusting entry to recognize the expense. Similarly, earned interest income not yet received is recorded in the period it was earned.

Deferrals adjust for cash received or paid in advance for future goods or services. Prepaid expenses, such as rent or insurance premiums paid upfront, are initially recorded as assets. An adjusting entry is made each month to recognize the portion of the expense that has been used or expired.

Conversely, unearned revenue, like customer deposits for services not yet rendered, is recorded as a liability. As the service is provided, an adjusting entry shifts unearned revenue to earned revenue.

Depreciation and amortization allocate the cost of long-term assets over their useful lives. Depreciation applies to tangible assets like machinery or buildings, reflecting wear and tear. Amortization applies to intangible assets like patents or copyrights, spreading their cost over their legal or economic life. These non-cash expenses align asset cost with the revenue they help generate.

Bad debt expense accounts for accounts receivable a business estimates will not be collected. The allowance method is commonly used to estimate this expense, often based on a percentage of sales or an aging analysis. This adjustment ensures accounts receivable are reported at their net realizable value, reflecting a more accurate financial position.

If inventory discrepancies were identified during preparation, formal inventory adjustments are made. These entries correct inventory records to match the physical count, often involving a debit to cost of goods sold or inventory shrinkage expense and a credit to the inventory asset account. This ensures the inventory balance reflects actual goods on hand and that any losses or gains are recorded.

Producing Financial Statements

Once adjusting entries are recorded, the next step is generating primary financial statements. The adjusted trial balance is the first output after these adjustments. It lists all general ledger accounts with their final debit and credit balances. This document confirms total debits still equal total credits, providing an internal check on the accounting equation’s balance.

The income statement (P&L) is then prepared. This statement summarizes a company’s revenues and expenses over the monthly period, culminating in net income or loss. It offers insights into the company’s operational performance and profitability.

Following the income statement, the balance sheet is produced. This financial statement presents a company’s assets, liabilities, and equity at a specific point in time, typically the last day of the month. It offers a snapshot of the company’s financial health, showing what it owns, owes, and the owner’s stake.

Many businesses also prepare a statement of cash flows. It details cash inflows and outflows during the period. This statement categorizes cash activities into operating, investing, and financing sections, providing a clear picture of how cash is generated and used. It complements the income statement and balance sheet by showing the business’s liquidity and solvency.

Supporting schedules are often generated alongside main financial statements. These detailed reports provide additional information and breakdowns for specific line items. Examples include accounts receivable aging reports, detailing customer balances by age. Fixed asset schedules list assets and their accumulated depreciation. These schedules offer deeper insights and support the figures presented in the summarized financial statements.

Finalizing the Accounting Period

The final stage of the month-end close involves several steps to formally close the books and prepare for the next period. This begins with closing temporary accounts, which accumulate balances for a single accounting period. Examples include revenues, expenses, and owner’s drawings or dividends. These accounts must be reset to zero at period-end so their balances do not carry over and mix with subsequent month’s transactions.

Balances from temporary accounts are transferred to a permanent account, typically retained earnings for corporations or owner’s equity for sole proprietorships and partnerships. This transfer moves the net income or loss for the period into the company’s equity. This ensures income statement accounts begin each new month with a clean slate, ready to accumulate new period-specific data.

After temporary accounts are closed, a post-closing trial balance is prepared. This trial balance includes only permanent accounts, such as assets, liabilities, and equity, which carry balances forward. Its purpose is to confirm total debits still equal total credits after closing entries. This verifies the accuracy of the closing process and ensures the books are balanced for the new period.

Filing and archiving financial documents, reports, and backup files for the closed period is a necessary administrative step. This ensures records are organized, accessible for future reference, and available for audits or tax purposes. Businesses are generally required by tax regulations to maintain records for a certain period, often three to seven years, depending on the record type and specific requirements.

The final action is preparing for the next accounting period. Confirm all opening balances for permanent accounts are correct. These balances serve as the starting point for new transactions, ensuring continuous and accurate financial tracking.