What does it mean to ‘close the books’ in accounting

Closing your books a year-end activity where business reports are finalised. “Books” refer to a company’s transaction records that are used to generate financial statements. These transactions inform the business owner about the money flowing in and out of their business.

What is the importance of closing the books

Closed books indicate that your finances are in order. Doing it properly will prevent inconsistency in your data as the income and expenses from the previous year will not get carried to the next. Closing out your transactions also allows your accounting software to generate annual financial reports, which inform you about your business performance.

How to close the books in 9 simple steps

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1. Update the general ledger: Many small scale businesses maintain account totals in different journals. For example, there may be separate accounting journals for cash inflow and outflow. These figures have to be updated on your general ledger accounts.

2. Calculate general ledger totals: Work out the total for each account by adding up all your entries. This will give you preliminary ending balances.

3. Get your preliminary trial balance: In the previous step, you calculated the preliminary ending balance for all accounts. In this step, add up all those ending balances to arrive at a preliminary trial balance. A trial balance is the total of all debits and credits, such that total debits is equal to total credits. If there is a mismatch between the two, then it’s likely that there was a mistake made in one of the previous steps.

4. Add adjustments: Transactions that are added as adjusting entries aren’t usually the ones that take place day to day. Some examples would be depreciation or real estate taxes. Once you have added these adjustments into your journal entries, add up the entries from all accounts again to arrive at your adjusted account balance.

5. Prepare a new trial balance: The next step is to add up all your adjusted account balances to arrive at your new trial balance. Check whether your debits and credits are equal. If not, revisit your calculations.

6. Perform variance analysis:  Many firms track their monthly expenses against their planned budget. Analysing these results plays a key role in tracking a company’s financial health. Variance analysis is a common method for doing this. It helps you correct mistakes and prepare necessary adjustments to your expenses by comparing your plans with the reports gathered after implementation. Accountants play a key role in preparing variance reports.

7.  Generate financial statements: If your debits and credits are equal, then you can proceed and prepare your three year-end financial statements: the balance sheet, cash flow statement, and Profit and Loss statement. These will help you understand your business financials.

8. Finalise closing entries: Get your general legder ready for the next financial year by setting revenues and expenses to zero. In this step, the values of temporary accounts are shifted to a permanant account.