Clean Up Your Books in Eight (or Nine) Steps – Cleanup Checklist
Bookkeeping is more than just a record of money in and money out. It helps businesses assess their past performance, evaluate their current operations, and plan wisely for the future. At least, it should. And you should follow a bookkeeping cleanup checklist – So in this post I share my thoughts on how I approach cleaning up books for hundreds of clients a year. If you would like to discuss your case in particular, please submit your case for evaluation here.
When a business’s accounting records fall out of order, its books no longer provide the guidance they were meant to. Nor do they provide compelling support for the business’s tax return filings in case of an audit. Sloppy or incomplete books may even prevent a business from qualifying for the loans, lines of credit, and investor funding on which its future growth rests. This guide is meant to walk you through the stages of a comprehensive accounting clean-up project, from the initial what-am-I-looking-at-here stage to steps you can take to ensure that your books remain accurate, comprehensive, and useful. It is addressed to small business owners, but the advice found here can help anyone faced with poorly maintained financial records, including independent bookkeepers. Too often, clients seek help with their books after years of doing their accounting in a shoebox. This can be an honest mistake—simple cash-basis accounting may be fine for a side hustle, but when business picks up, the old approach simply doesn’t work. Divorce and other major life events can also make a good-enough approach to finances suddenly appear painfully inadequate. Whatever the reason for getting a handle on the books, whether you own a small business or are helping someone who needs a more complete and accurate view of their finances, this guide can help you map out a successful strategy.
Identify the Problem(s)
If you literally keep your records in a shoebox, you probably know that there’s some room for improvement. But if you think that you’re doing just enough to maintain accurate books, you might be whistling through the accounting graveyard. It’s easy enough for minor problems and chronic oversights to go unnoticed for years, but it’s all too easy for them to snowball into serious issues.
Here are some of the most common signs of significant recordkeeping issues.
- Cash-balance discrepancies
- Negative cash balances
- Unexpected interest charged on credit accounts
- Fees or penalties charged by lending institutions
- Inaccurate asset valuation and capitalization
- Incomplete or inconsistent invoices
- Unauthorized withdrawals
- Non-updated inventory level statements
- Changes in payment terms from suppliers
These problems are easy to spot when you look for them, and they tend to indicate systematic problems with a company’s books. If one or more of these issues crops up, you’ll need to thoroughly audit your records and establish a steadier course for the future. But first, you’ll need to stop the bleeding.
Stop Further Damage
Bookkeeping Cleanup Checklist most overlooked item.
After locating the source of your problems, you’ll probably be tempted to jump right in and begin fixing them. It’s wiser, though, to take a breath at this point and ensure that your books suffer no further damage.
The key to this step is making sure that all incoming documents are handled by a reliable accounting system under the eye of a reliable bookkeeper. This can be as much a personnel decision as an accounting one. Too often, small business owners continue to manage the books themselves, even after the business has grown and its accounting needs have changed. If keeping your records in a shoebox was a good enough system three years ago, it’s clearly not enough at this point. Other businesses assign bookkeeping responsibilities to employees who lack the experience to follow through correctly.
If you’ve been outsourcing your bookkeeping, it’s time to find a new accountant. If you’ve been keeping the books yourself or with in-house personnel, it’s time to get some extra training for the person who’ll be managing things from here on out. For now, you may well need to take control of the process yourself, at least for a little while.
For most small businesses, a simple accounting software package is all you’ll need to get things back on track. If that means investing in new software, choose a program that allows you to create retrospective ledger entries (more on that in step 5). No bookkeeping cleanup checklist will ever be enough if you do not stop the systematic errors that got your books to this point.
Centralize Management of Source Documents .
It might have seemed efficient to have invoices sent directly to one department, billing statements to another, expense reports to still another, and so on. But internal efficiency isn’t your biggest problem at this point. It is far more important that one person at the company be responsible for receiving and distributing all source documents related to your finances. Once each document is accounted for, you can send it (or a copy) quickly to its final destination.
Analyze Each Problem Area
Finally, with a steadier hand keeping the books and all incoming source documents fully accounted for, you can start addressing the problems you’ve found.
This guide can’t anticipate every problem you might have discovered, but we can give you some ideas about issues common to businesses in your situation, and how you should plan to correct them.
Establish a Clean System Moving Forward
You’ve chosen a new bookkeeping system, identified the problems that affected your old one, and analyzed your books to see what exactly is wrong. Now it’s time to begin building a complete, accurate set of books for the future.
As with step 2, this might seem counterintuitive: if you’ve just analyzed your problems and figured out what needs to be done about them, why not fix them right away? The reason is nearly as simple and much more practical: when you get your books in order looking forward, it’s easier to bring past records into line.
Begin by setting up a chart of accounts in your new accounting software and entering each transaction completely and accurately. A healthy set of books is built entry by entry, and the experience will help sharpen your eye for anomalies in your older records.
Before long, you’ll have a solid general ledger and be able to generate a simple income statement. That’s the easy part. Producing a proper balance sheet at this point will require accurate historical records, which presents a bit of a Catch-22. You’ll need to use what you can from your older source documents to reconstruct general ledger transactions for prior periods.
Some accounting software might not allow you to create retrospective ledger entries until you have entered every transaction for the current fiscal year and restarted the general ledger. In that case, you’ll need to rely on a trusty old spreadsheet for the time being to record transactions from previous fiscal years.
You might also just create the prior reporting periods and leave them empty while you continue to create a clean set of books with accurate ledger entries representing the current fiscal year. You’ll get to those prior periods in the next steps. Adapting this bookkeeping cleanup checklist for your needs, and following it monthly, will ensure a clean set of books.
Reconcile Your Cash and Credit Accounts
A proper bookkeeping cleanup checklist would be incomplete without this. When your current books are in order and you’ve established a solid process for receiving source documents and recording their information, you’ll be ready to build a clean, accurate retrospective ledger.
You’ll start by reconciling your cash accounts, and repeating the process for your credit accounts. This is such a fundamental clean-up activity that you should count on undertaking it even if you haven’t seen any red flags.
If your books have been kept less than perfectly, they might be papering over chronic shortages in your cash accounts. Gather your bank statements as far back as you can, then spot-check your end-of-month balances for each period. This should give you a rough idea of whether things fell out of sync, and when.
You may be tempted to enter as much information as possible here, but you’ll want to limit yourself to information that meets two criteria:
- Each transaction must be verified against a source document.
- Each transaction should be verified against your bank statements.
Your bank statements are the fundamental records for your books, and crucial for your bookkeeping cleanup checklist.
Not only should they describe your full cash flow, both incoming and outgoing, they should also be accompanied by images of each deposit slip and check.
Start by collecting every source document you can, even if it’s stored in a shoebox, and correlating each with an entry in a bank statement. Cross off each bank-statement entry that matches a source document, and create an entry in your software’s journal reflecting the details of each transaction.
Some of your source documents will have been issued too recently to match up with your bank statements. These should all fall into one of two categories: unpaid supplier invoices, or accounts payable, and unpaid customer invoices, or accounts receivable.
Then flip the script and start with the items you haven’t crossed off your bank statements. Some of these might seem too trifling to bother documenting—if you’ve been keeping your own books, you might remember most of them—but don’t consider anything fully accounted for until you have a source document to confirm it. You might need to contact customers or suppliers to see if they have copies of a missing invoice or billing statement. Don’t be shy. Get the documentation.
Once you’re done, it’s wise to make a plan to reconcile your cash accounts regularly. Some accounts may warrant a monthly reconciliation, but cash accounts that are used heavily, or for a wide variety of purposes, may warrant biweekly or even weekly reconciliation.
When you’ve reconciled your cash accounts, do the same for any lines of credit. This should be a quicker process, in part because there ought to be a close relationship between the payments you have made on your credit lines and your newly reconciled bank records. Be sure to record any interest paid on lines of credit as an expense, and keep an eye out for especially unusual activity, such as negative balances. As with your cash accounts, plan to reconcile each credit account once a month going forward.
This step might take a few days, and it might take much longer. If your books have been in disarray for years upon years, you might be tempted to draw the line and stop the reconstruction process. It’s vital that you clean up the last three years of records, and best if you go back seven years. Beyond that, you might not get much practical value from the exercise, and it’s unlikely that anyone else will ask you to go back any farther.
Correct Additional Issues
Once you’ve done the bedrock work of reconciling your cash accounts, you can move on to other issues affecting your books. None will be as important as verifying your cash flow against source documents, but each of them contributes to an accurate picture of your business and its true value. And they’ll all help you manage your taxes more effectively.
- Assign Proper Valuations to Your Fixed Assets
You should be able to establish the basis for the value you claim for any fixed asset. Make sure that this basis is documented. You must also choose a depreciation method to claim tax advantages against each asset’s basis throughout its expected useful life. Include the method you used, and a full depreciation schedule, in the documentation you retain for each asset.
- Record All of Your Assets, Not Just Fixed Assets
Assets like intellectual property may not be subject to depreciation schedules, but they certainly represent value to your company. Tangible or intangible, your assets should be regularly valued, and those values should always be recorded as positive: if your liabilities exceed the value of your assets, you may have negative net assets, but the value of any given value should never be negative.
- Confirm Your Inventory Levels
Inventory may be the lifeblood of a retail business, but it also represents assets that can be converted to cash. In that sense, inventory is a critical element of bookkeeping.
- Document Inter-Business Activity
If you own multiple businesses, you’ve likely moved cash between them. This is especially common for very small businesses whose net profits are reported as pass-through income. Even if the combined revenue streams for multiple companies will ultimately be joined in a personal tax return, you’ll want to keep their books separate, and to document all inter-business financial activity clearly. You might never be audited, but if you are, you’ll want to be able to prove that every penny was accounted for properly.
- Match Retained Earnings with Tax Returns
Speaking of tax audits, you’ll want to finish your analysis by comparing the business’s retained earnings with its tax filings. If the business is especially small and its retained earnings are recorded as pass-through income, this can be a straightforward process. If multiple owners hold shares in the business, calculate the funds remaining after the owners have received their proceeds and compare it to the earnings reported on the business’s tax return.
- Customize your own bookkeeping cleanup checklist based on the above.
Create New Financial Reports – Second to Last item on your Bookkeeping Cleanup Checklist
By the time you clean up your records back to the beginning of the current fiscal year, you’ll have what you need to produce your business’s most fundamental reports. For starters, you’ll have an accurate balance sheet, along with basic sales and profit numbers. If you went back at least a few months, you’ll also have enough information for aged accounts payable and aged accounts receivable reports.
At this point, you can go ahead and restart the general ledger as of the start of the fiscal year, at which point you can enter (or upload) data for the earlier transactions you’ve documented. If you’ve already created empty reporting periods, you can now populate them. Your Bookkeeping cleanup checklist should
Move to the Accrual Basis
Bookkeeping Cleanup Checklist most important item.
This step may not apply to all businesses, but it’s a common enough issue.
Many small businesses begin as side projects; many barely record sales or revenue at first. In those early stages, bookkeeping isn’t a pressing issue. Most fledgling businesses keep records of when they receive cash from sales or spend cash to cover bills, and leave it at that. This approach, cash-basis accounting, may paint an accurate enough picture of each transaction, but it does little to help business owners project revenue, adjust inventory levels, plan for capital investments, or even chase down overdue payments.
If your business still handles its books this way, you should strongly consider moving to the accrual method of accounting, and this is the perfect time to do so. The accrual basis records transactions not when cash is exchanged but at the moment it is committed, through invoicing, purchase contracts, or other agreements. Each invoice received from a supplier or sent to a customer is entered as its own item, giving your business a much clearer and more accurate understanding of its month-to-month cash flow, and a much better historical record.
To make the switch, you’ll need to go back through your newly cleaned-up records for earlier periods to record not just the cash transactions behind your business but the accrual expenses—those invoices and other agreements—as well. It’s a bit more work at the end of an already-long process, but it’s worth it. And you’ll only need to do it once.