Closing the Books

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How quickly should a company be able to close its books?  While the topic is widely debated, the answer is usually quite simple.

To understand the ramifications of the speed of closing the books, it is important to understand why we do it.  Closing the books allows a company to generate financial reports for the most recent period.  Ultimately, financial reports are supposed to provide business managers with useful information for decision making.

Let’s explore this idea.  Financial information is not simply a static exercise in order to understand business “history.”  Rather, it is a way to learn from history.  If we understand why the business performed in a certain way, we can use that knowledge to improve future results.

Let’s get back to the idea of “useful information for decision making.”  Ideally, business managers would have the results of the most recent period as soon as the period ends.  At the other end of the spectrum, if information becomes available months later, it’s probably not very useful.  Generally, the sooner we have business results, the better our ability to appropriately respond.  This is the balance we seek when ensuring the timeliness of reporting business results.

What prevents us from knowing business results as soon as a period ends?  Typically, we must accrue expenses to accurately match against the period’s revenues.  Oftentimes, these expenses are recurring ones such as utility bills that may vary in amount from month to month.  To the extent we can estimate expense accruals, we can close the books earlier rather than waiting to know the exact amounts.

Reversing entries provide the perfect tool for recording estimates.  These entries will allow for calculating business results for the most recent period.  At the beginning of the next period, they “reverse” themselves, allowing corrected entries to replace them and update the accounting records for greater accuracy.

The detailed nature of individual accountants can cause them to dislike estimates, preferring instead to wait for “perfect” knowledge of expense amounts.  However, estimates are an integral and necessary part of every accounting system.  For example, every organization that depreciates fixed assets uses estimates — in terms of useful life, depreciation method, and salvage value.

The goal of every accounting system should be to balance accuracy with the utility of having useful (i.e., timely) information for decision making.  While the speed of closing must be determined by each organization, it is often reasonably attained within a few business days of the end of the accounting period.  If you want a quicker close, it may require more significant (i.e., potentially less accurate) estimates.  On the other hand, if you prefer greater precision, a longer closing period may be preferable.  In any case, for maximum responsiveness to current business conditions, I recommend understanding your recent business performance by the middle of the following month (i.e., about 15 days later).

 

Are you learning all you can from your financial reporting?  Counterpart CFO specializes in helping organizations understand the past so they can put that knowledge to work.

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