Many small business owners look at their books once a year, when the tax return is due, and discover that the numbers do not mean much. The fix is a monthly close: a fixed routine, done on a fixed date, that turns the prior month's transactions into a set of statements you can trust. Here is what a close includes, why the people who lend you money or buy your business will ask about it, and the messes we see most often when there has not been one.
What a monthly close includes
A close is a checklist. The exact items depend on the business, but the core is the same for a two-person consultancy and a fifty-person contractor:
- Reconcile every bank, credit card, and loan account to the statement, so the balance sheet matches what the bank says.
- Post payroll from the payroll provider's reports, splitting gross wages, employer taxes, and withholdings, rather than booking the net cash that left the account.
- Review receivables and payables. Send statements, write off what is uncollectible, and record bills received but not yet paid.
- Record sales tax collected as a liability and match it to the return you filed.
- Book fixed asset purchases to the balance sheet with the invoice attached, so depreciation can be taken at year-end.
- Clear the holding accounts. Undeposited funds, uncategorized expenses, and ask-my-accountant should be empty at close.
- Read the statements. Compare the profit and loss to the prior month and the same month last year, and explain anything that moved.
- Lock the period so nothing changes after the statements go out.
A reasonable target is to have the prior month closed by the 15th. Businesses with inventory, job costing, or multiple entities need a longer list and usually a longer timeline.
Why the tax return depends on it
Your business return, whether Form 1120-S, Form 1065, or Schedule C, is built from the books. When the books are closed monthly, the return is a reporting exercise. When they are not, the preparer spends billable hours reconstructing the year, deductions get missed because receipts are gone, and estimated payments made during the year were based on numbers that turned out to be wrong. A closed set of books also lets you do real planning in November, when there is still time to buy equipment, fund a retirement plan, or adjust salary, instead of learning the result in March.
Why lenders care
A bank reviewing a line of credit or an SBA loan will ask for interim financial statements, usually the most recent quarter, and will compare them to the tax return. Statements that reconcile to the bank and tie to the return get approved. Statements that show negative cash, a loan balance that does not match the lender's own records, or a balance sheet that does not balance get a follow-up letter and a slower answer. Many lenders now require a monthly or quarterly accountant-prepared statement as a covenant on the loan itself.
Why buyers care even more
If you ever sell the business, the buyer's first request is three years of monthly financials, and the second is a quality-of-earnings review that tests them. Every unreconciled account, every personal expense run through the company, and every year where the books and the return disagree becomes a reason to lower the price or extend the diligence. Owners who have closed monthly for years get through diligence in weeks. Owners who have not spend months rebuilding history and often accept a discount for the uncertainty.
The messes we see most often
Loan payments booked as expenses. The principal portion belongs on the balance sheet. Booking the whole payment as an expense understates profit and leaves the loan balance wrong.
Owner draws booked as wages, or wages booked as draws. These have different tax treatment, especially in an S corporation, and swapping them changes the return.
Personal spending in the business account. Beyond the tax problem, commingling weakens the liability protection the entity was formed to provide.
Sales tax counted as revenue. The business looks more profitable than it is, and the sales tax liability is missing from the balance sheet.
A large opening balance equity account. This usually means the file was set up without a proper starting balance sheet and nobody went back to fix it.
Years of unreconciled transactions. Once reconciliations stop, every month after is guesswork. Fixing it means going back to the last clean month, however far back that is.