Improving the Financial Close Process, a Practical Guide
Background
In the modern information age, business moves faster than ever before. We are bombarded by
information from an amazing array of sources and, at times, it can be difficult to keep up with
the rapid pace of new information.
Despite technological advances, many manufacturing and distribution companies have
accounting departments that still move through their monthly close process at a pace that was
deemed acceptable back at the dawn of the industrial age. Many take several weeks, or in
worst case scenarios, months to close their books on a monthly basis. By the time the
information is provided to management and other stakeholders, it has often lost much of its
relevance.
In too many companies the close process is a chaotic period with rapidly approaching deadlines
that are close to overwhelming. This frantic environment increases the level of stress within the
department, increases the risk of errors, and prevents team members from taking a step back
and looking for ways to improve the process overall.
There is no simple solution to the complex issue that is the monthly close process. But with a
careful retooling and rethinking of the process, significant change can be accomplished in a very
short period of time. This requires a new way of looking at the close process, and getting past
some of the institutionalized thinking that has many accounting departments mired in the
details.
This document will explore several techniques that facilitate reducing the overall time required
to close the books, while at the same time leveling out the work load in the accounting
department, making the close a well thought out systematic process.
Develop a Close Timeline
The first step is to develop a detailed timeline for the monthly close. This timeline will act as
your monthly roadmap and will help set expectations for all members in the department. It will
outline when all of the significant events in the close process will be completed, culminating
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with the release of the statements to stakeholders. The first time such a calendar is drafted, it
should reflect the company’s current capability to close, as it will be used as a baseline to
measure future improvement. In other words, it is not a best case scenario, it reflects what the
department was actually able to accomplish during the previous month’s close.
The close timeline should include a detailed listing of all significant steps in the close process
such as account reconciliations to be performed, adjusting entries to be posted, running of
reports, the review of draft financials and the list goes on. Each one of these steps needs to be
assigned to the person who has responsibility for performing them.
As is the case with most successful plans in business, this close timeline should not be
constructed in a vacuum. It is critical to have open two way discussions about the tasks and due
dates with each person responsible for them. This will ensure that they have bought into the
calendar and believe it to be a reasonable expectation of them.
This close timeline needs to be a living document that is updated and refined on a continual
basis and published each month. The close process should start off with a monthly department
meeting where that month’s close timeline is presented to the group and any unusual
transactions or other situations impacting the close process would be discussed with the team.
Everyone in the department should have a copy of the close timeline each month, and should
be clearly aware of their responsibilities in the close process.
Define the critical path
With the detailed close timeline in hand it is time to look for ways to make the close process
more efficient. The most effective method to find the areas for improvement is to perform a
critical path analysis.
In the monthly close process, an item on the critical path would be one that directly impacts the
completion date of the close. That is to say that if that task is not finished on time, it would
delay the close. Conversely, these are the items that are preventing an earlier completion of the
close. In most situations, the close timeline will likely show that there are a few significant
items on the critical path and these are the items that should be focused on initially.
With these tasks identified, the next step is to find ways to complete them earlier in the cycle.
Remember that the overall success in reducing close time will be the culmination of many
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smaller improvements that in the aggregate are substantial. We have identified six issues that
are the key to successfully improving the close process. They are:
•
•
•
•
•
•
Don’t passively wait on information
Start the close process before month end
Operate in real time
Make reasonable estimates
Reduce or eliminate manual processes and the use of Excel
Minimize month end journal entries
Next, we will take a closer look at each one of these issues, along with some examples of how
they impact the close process.
Don’t passively wait on information
All too frequently, a team member in the accounting department will state that certain account
reconciliations cannot be completed because necessary information has not yet been received either from another department or from a third party. This could be an invoice from a vendor, a
payroll report from a payroll processor, or information from the warehouse. Many employees
in the accounting field will passively wait for information to arrive on their desk, instead of
proactively seeking out the information they need by simply requesting it.
We have seen situations where companies are waiting on hard copy statements to be received
in the mail which takes days or sometimes weeks to receive. When asked why it is necessary,
many accountants will give the response of – “that is how we have always done it” or make
excuses that the vendor cannot provide it electronically.
These basic assumptions need to be challenged. While it might have been the case years ago
that such information was not available electronically, situations change, and it is unlikely you
are the only client of that vendor that wants that information sooner. A simple phone call or email can sometimes yield tremendous results, but only if the query is actually made.
In situations where required information cannot be obtained in a timely manner, alternative
approaches should be considered. An estimate of an account balance based on historical results
can often yield materially correct results or the data can be derived from other sources. More
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drastic measures include changing to new more responsive vendors that are able to supply the
information in a timely manner.
Start the close process before month end
Many companies look at their month end calendar as starting on the first day of the following
month. This traditional way of thinking needs to be eliminated by starting the close cycle
several days before the end of the month.
Review the close timeline and consider what accounts can be finalized in advance. Here are
some examples of activities traditionally performed during the close that sometimes can be
done before the end of the month:
•
Allowance for uncollectable accounts receivable – Perform the analysis and determine
the appropriate allowance balance in the week before the end of the month. This
number would also include an estimate for the activity for the last few days of the
month if deemed significant. If a significant event occurs during the close, that
information could be used to revise the allowance, but in most companies such late
changes are highly infrequent.
•
Depreciation expense – Consider adopting a depreciation policy where assets acquired
during the first half of the month receive a full month of depreciation and those in the
second half do not start depreciating until the first day of the next month. If consistently
followed, such a policy is GAAP compliant and does not produce results that materially
differ from other acceptable policies, and will allow the posting of the monthly
depreciation entry before the end of the month.
•
Inventory counts – Consider moving from a traditional count of 100% of inventory at
period end to cycle counts. This will spread the inventory count process over the
reporting period and will eliminate a significant amount of work that occurs during the
close. It can also eliminate significant month-end adjustments as those will be recorded
in real time during the month.
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Operate in real time
The processing of and reporting on accounting information in real time has been widely touted
as the way all information will be processed in the near future. Operating in real time allows for
immediate identification of problem areas and rapid responses. It balances out the workload so
that information is processed and reviewed during the month, not days or weeks after the fact
during the close.
However, with currently available technology this approach is only practical for certain
accounts for most companies. It is therefore important to identify which components of the
financial reporting process can be made to operate in real time.
A controller at a middle market Company gave us the following example of how to make real
time processing work:
When I started examining the accounting department’s existing close process, it was
clear that many workloads were imbalanced, and this was causing the close process to
take an unacceptably long time to complete. An excessive amount of work was
performed by the team during the close process, and the rest of the month they had
excess capacity. I started looking at our process for recording sales which involved a
point of sale system that was not linked up to our accounting software. This process had
traditionally been done at month end, which entailed having the accounting department
recording 30 days of activity and perform all of the daily reconciliations at month end.
This, I was told, was required because of the inability of our point of sale software to
provide daily reporting, a fact which I refused to accept.
I met with our IT department to discuss the situation. They indicated that they already
had a report that provided 90% of the daily information we needed, and that with a few
coding changes, they could get it to 100%.
Two weeks later, we were recording sales on a daily basis. Initially, this increased the
total amount of work performed by the accounting team, but in time additional smaller
efficiencies were discovered in the process to reduce the necessary effort. The key part
here is that sales and cash receipts were now an integrated process, and both of these
significant accounts could be completed the first day of the close, instead of the 10th
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day. Sales and cash went from being one of the most significant challenges to a timely
close to something that was a non-event.
The above scenario illustrates, these changes not only reduced the work load at month end, but
resulted in more accurate information. The accounting department had more time available to
investigate variances in information, and because the inquiries on variances were being made
the next day, it was easier for the operations team members to recall and provide explanations.
It also allowed for new reports to be sent out to management on a daily basis, providing them
with additional analysis of key information.
Make reasonable estimates
When determining the various reserve calculations that go into the monthly close process, it is
important to provide the appropriate level of precision in the underlying estimates. For
example, consider the sales return reserve. At month end, a detailed analysis could be
performed of all transactions, credit memos issued subsequent to month end could be
reviewed, or other sophisticated techniques could be used to calculate this reserve with a high
level of precision.
In many situations though, if sales returns are fairly constant over the year, a simple calculation
involving reserving for a certain percentage of current months sales based on historical return
rates will likely yield a result that is materially consistent with the more complex approaches.
Keep in mind that the objective of rethinking the monthly close is not just to get it done faster.
The objective should be to put meaningful information in the hands of decision makers earlier.
If a number cannot be estimated with appropriate accuracy and reliability, it is imperative to
take the time to get the numbers right. The information provided by the accounting
department must be accurate enough to be the basis for informed decisions. Any numbers that
do not meet those criteria for reliability need to be refined further so that they can play an
effective part in management’s decision making process.
Reduce or eliminate manual processes and the use of Excel
The automation of routine and repetitive tasks is key to efficient accounting operations.
Although Excel is an exceptionally useful tool to accountants, it is important to remember that
it is not an automated process. Review your close timeline and list out all of the reports that are
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generated in the department including those intended for internal reconciliations or
management analysis. Frequently, a significant number of these reports are system generated
and then manipulated in Excel to reformat or to add additional information.
Many report writing programs such as Crystal Reports or Management Reporter have
capabilities far beyond their utilization at most companies. Automating certain reports may
require a restructuring of related general ledger accounts or the input of non-financial data
(such as headcount or number of shipments) into the general ledger as a memo entry, but in
the long run it will serve to automate the process of generating these reports, as well as
providing a strong audit trail when things do not go exactly right.
One of the easy ways to determine the amount of your Excel usage during the close is to keep a
log of every time you use Excel during your close and to catalog the spreadsheets that are part
of the current close process. This will give an accurate picture of the current level of reliance on
Excel and can be the starting point for identifying processes to automate.
One of the frequent reasons many companies have a significant reliance on Excel is the inability
of their accounting systems to process transactions in a particular manner. In talking with many
clients over the years, it is not that the system will process balances incorrectly, but it comes
down to a preferential formatting issue. Further inquiry typically reveals that the company had
processed the transaction differently with their old system, and that they are not comfortable
with the particular method in which the new system processes the transaction.
In order to obtain higher levels of efficiency, preferences for formatting or particular
methodologies must sometime take a backseat to practicality. If there is a way a system can
automatically process a transaction and remove it from the world of Excel, it will typically result
in substantial increased efficiency and it can be well worth the tradeoff. Other times, it may
require the rethinking of why transactions are processed in that particular way, and frequently
they can be altered to fit into the constraints of the accounting system. The key is to work to
process transactions in a way that works in the system, not forcing the system to do something
a little different.
Minimize month end journal entries
Journal entries are inherently a manual and inefficient process, representing a non-routine
activity. There are essentially two reasons why journal entries are recorded – they are either
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the correction of an error or they are made to record a non-routine transaction. In either case,
it is advantageous to limit the number of these entries.
Run a report of all journal entries made during the last three closings, and investigate them for
recurring trends. Are there certain errors that continue to be made month after month that
require journal entries? Are there other transactions that can be recorded in a different module
in the accounting system?
There are also certain entries that are known amounts throughout the year, such as deferred
rent or amortization of prepaid expenses. Using the journal entry upload function in the
accounting system, these transactions can be uploaded once for future periods, and then
posted on a monthly basis if there have been no changes in the underlying transaction during
the year.
Brainstorm
Select one or two of the identified critical path items, and start to explore some potential
solutions with your team. Employees are more familiar with their tasks than anyone else, and
they are likely aware of procedures that are not working well. As a starting point, ask the team
members what it would take for each of them to complete their tasks one day earlier. Have
each of them review the tasks on their desks to identify impediments and solutions for
expediting those processes.
Each of these ideas should be discussed within the group to see if they are viable solutions.
Often times an idea that initially sounds promising might have unforeseen consequences either
to the close process or to the internal control structure. Alternatively, an idea to improve in one
area could be applied to other areas for additional efficiencies. Any changes to policies and
procedure need to be thoroughly vetted before their implementation.
It is critical that these discussions result in realistic changes that are obtainable. Improvements
in the close process should not simply be a mandate from management that everything will be
done one day earlier. It is about working together to change the process to achieve a goal of
reducing the close time. It is about real change, not just forcing team members to work harder
or longer hours.
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Year-End
Although the reporting of monthly results is important, there is no dispute that year-end results
have an increased significance and importance to every company. These are the numbers that
will be provided to many stakeholders of the entity, and will be subjected to external audit or
review by the company’s CPA firm. Accordingly, it is both appropriate and efficient fort the
year-end close process to be more robust that the monthly close.
This would include more rigorous assessment of certain assumptions used all year long,
investigation of contingencies for unsettled matters, more thorough analysis of reserves and
other estimates, an evaluation of accounting policies for complex transactions, and the drafting
of the financial statement footnote disclosures.
The close timeline at year-end should reflect the additional effort required as noted above. A
robust review process by management should be in place before any information is provided to
outside stakeholders or to the Company’s auditors to ensure that they numbers are reliable and
final. Any adjustments to the numbers once they have been distributed will undermine the
credibility of the Company’s ability to produce accurate financial reports.
GALLINA can help
The implementation of changes to a company’s monthly close process can yield substantial
results. Such an implementation may encounter numerous challenges, but the experts at
GALLINA can help. If you have any questions, please feel free to reach out to us to discuss the
right steps for you and your company.
For more information about how GALLINA LLP can help you achieve your financial goals, visit our
web site at www.gallina.com.
*****
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