All you need to know about closing your financial books.
I am so excited to share my end of year bookkeeping checklist in this article. Preparing your end of year accounts is an important task for any business: I have helped a number of small arts companies inc closing their accounting books and submit their accounts to HMRC, and this makes me familiar with the main questions and knowledge gaps that directors of small businesses have about year end bookkeeping.
As a Director, it’s important to ensure that your company’s financial accounts are prepared correctly and in accordance with best practice, to avoid any penalties or fines from HMRC, and to ensure that the final reports reflect the truthful financial position of the company. In this blog post, we’ll cover the bookkeeping tasks you should make sure are completed, as well as the checks you should carry out to ensure your accounts are in good shape for submission to HMRC.
This article will be most beneficial to small business owners who recently incorporated a limited company, and want to make sure they are following best practice when preparing their year end accounts.
What we’ll cover:
- What is accrual accounting?
- Why you should use an accounting software if you have a small business
- End of year bookkeeping checklist
Disclosure: There are some affiliate links below and I may receive commissions for purchases made through links in this post, but these are all products I highly recommend. I won’t put anything on this page that I haven’t verified and/or personally used.
What is accrual accounting?
Before we jump into the end of year bookkeeping checklist, it is absolutely crucial that you understand what accrual accounting is, and how it differs from cash accounting.
Accrual accounting is a method of accounting that records financial transactions when they occur, regardless of when the money is received or paid. In other words, revenue is recognized when it is earned, and expenses are recognized when they are incurred, regardless of when the cash is received or paid out.
For example, if a theatre company is selling tickets for a show that will happen in the next financial year, the revenue is recognized in the month the show happens, not when the cash is received from the box office system. Similarly, if a company incurs an expense, such as paying for rent or salaries, the expense is recognized when it is incurred, even if the payment is not made until a later date.
Accrual accounting provides a more accurate picture of a company’s financial performance because it recognizes all revenue and expenses when they occur and when the actual activity happens, rather than only when the cash is received or paid out. This method of accounting also helps to match revenue with the expenses incurred to generate that revenue, providing a clearer picture of a company’s profitability.
In contrast, cash basis accounting records revenue and expenses only when the cash is received or paid out, rather than when the transaction occurs. For example, this method is used by most freelancers when they submit their Self Assessment. If you are a sole trader and have submitted a Self Assessment, you have probably only declared the income that actually hit your bank account within the tax year, and you haven’t included the income that you have invoiced for, but hasn’t been paid to you yet. Under cash basis accounting, revenue is recognized only when the cash is received, and expenses are recognized only when the cash is paid out.
While cash basis accounting is simpler than accrual accounting, it can lead to a distorted picture of a company’s financial performance, especially for companies that rely on credit sales or have significant accounts payable (they are late in paying invoices) or accounts receivable (their clients are late payers). Accrual accounting provides a more accurate and complete picture of a company’s financial position, and it is the preferred method of accounting for most businesses.
In any case, limited companies are due to follow accrual accounting rather than cash basis, so if you are preparing end of year accounts for an incorporated entity, you should be familiar with what accrual accounting is, and follow its principles as you follow the end of year bookkeeping checklist.
Why you should use an accounting software if you have a small business
Another important point I want to make is that you should invest in a cloud-based accounting software if you are managing a small business. It might be a small extra cost per month, but it will save you hours of time every month, and it will prevent a number of human errors that anyone is just bound to make when trying to manage a business while relying solely on Excel and other spreadsheets.
My favourite accounting software is Xero, as it is the most user-friendly and, in my opinion, it has the best, most versatile reports. It also has a number of integrations and free add-ons that will make your accounting life a lot easier. That being said, there are a number of accounting softwares out there that will do just fine, such as Quickbooks or Sage.
I recommend having an accounting software for a number of reasons:
- They can sync with your bank account and imports a direct feed without the need for you to do this manually.
- You can more easily reconcile all your different accounts with just a few clicks
- You can have a paperless system by uploading your receipts and invoices on the system
- You can more actively monitor which invoices are still payable and receivable at any given time
- You can run a number of incredibly helpful reports, such as a Profit and Loss report, and an Actual vs Budget report
- You can track each transaction in more than one way: for example you can assign every transactions its own project, monitoring the profitability of each project, and how well each project is doing against budget.
The only challenge about using an accounting software is the initial time it requires to get familiar with it, but please don’t let this be a reason not to try it at all. There are mountains of free resources on youtube as well as the ones provided by the software providers themselves that can help you get the hang of it. I promise it’s not as difficult as you might think it is, and most of these programmes are made to be as user-friendly as possible.
I highly recommend setting up an accounting software for your small business as soon as you can, to make the process of closing the year end financial books much smoother and easier for you and your team.
The ultimate end of year bookkeeping checklist
Now that we’ve established that accrual accounting is, and how helpful accounting softwares are, we’ve not reached the fun part: the ultimate end of year bookkeeping checklist.
Here are all the steps you should take to ensure your end of year account procedure is complete:
1) Reconcile all bank and cash accounts.
This means that you should check that all transactions from your bank account are coded and marked as reconciled on the accounting software. It also means that if you have any other forms of cash lying around (for example: Petty Cash boxes and expense cards such as Soldo) all the transactions from those accounts need to be recorded,
A good way to check this is to ask yourself these questions:
- Does the bank balance on the accounting software match the bank balance on the bank statement on the last day of the financial year?
- Does the cash in the petty cash box match the balance shown as being petty cash on the accounting software on the last day of the financial year?
- Does the balance shown on my expense card account match the balance shown on the accounting software on the last day of the financial year?
2) Run a Profit and Loss report for the year and check for any unusual amounts
If you are in the habit of tracking your financial position every month, then nothing should come as a surprise at year end, as hopefully you will have identified and tracked every item of income and expenditure on a regular basis.
However, it is good practice to run a profit and loss report for the entire financial year, and look out for any odd amounts that need to be investigated.
For example, if your rent expenditure in one month seems to be much higher than usual, you should check why that is, as the same invoice may have been posted twice.
3) Check your Fixed Asset Register and run depreciation
If your company bought an asset during its financial year, you should make sure that it is added to the fixed asset register on your accounting software.
A fixed asset is something of value that your company owns that isn’t liquid (this means that it isn’t cash), that is used to deliver the services and/or products that you are offering. For example, a computer is an asset, as is a company car, or a new piece of equipment that cost more than £500 that you will be able to use over the years.
When a company purchases a fixed asset, it needs to be recorded as such at the moment of purchase, and then it needs to depreciate over the years until its book value is reduced to almost zero, and then written off.
So, when you are preparing your year-end financial books, you should ensure that the depreciation of any asset is run correctly. There are several methods for depreciating a fixed asset, and you should choose the one that is most appropriate for the fixed asset under question. Here is a great resource on the various depreciation methods you can use.
The accounting software you are using should also provide information and resources on how to run the depreciation for your company’s fixed assets.
4) Reconcile VAT
Your company needs to register for VAT if its total VAT-taxable turnover for the last 12 months was over £85,000 (the VAT threshold).
The VAT-taxable turnover is the income that you have earned that isn’t VAT exempt. For example, if your company is a consultancy business, that is a VATable service it is selling, and therefore it will need to register for VAT if its consultancy turnover has been over that threshold in the past 12 months.
However, if your company’s turnover mainly comes from selling insurance, it might be exempt from having to register for VAT, as insurance is a VAT exempt service.
If your company is VAT registered, you will need to reconcile its VAT account at the end of the year. This involves checking that its VAT return matches your accounting records, and investigating any discrepancies within the VAT control account.
5) Prepare Year End Adjustments
Now, here is where that whole section on accrual accounting becomes relevant: you need to make sure that both income and expenditure are accounted for in the period where they were incurred.
This means that you might have to make a manual adjustment through an accounting journal to ensure that the financial activity is recorded correctly and in the right period.
Questions you should ask yourself:
- Is there any income received or invoiced for this year that should be deferred to the next financial year?
- Is there any income earned this year that I will invoice for or that will be paid to me next year?
- Are there any expenses that I’m paying for this year that should be allocated to next financial year?
- Are there any expenses that will be invoiced to me in the next financial year that were incurred in this financial year?
Let’s look at some examples of accrual adjustments you may need to make to prepare your year end accounts.
Example 1: Deferred income journal entry
You are a theatre company and you receive box office income for a show that will happen in the next financial year: that income needs to be deferred to the next financial year
This will require a deferred income journal entry.
Date: First day of the following financial year
DR Deferred income
CR Box Office income
The box office received in the current year will also need to be coded to Deferred Income.
Example 2: Prepayment journal entry
You receive an invoice from a freelancer for a service they will offer in the next financial year: that cost will also need to be deferred to the next financial year.
This will require a prepayment journal entry.
Date: First day of the following financial year
DR Freelancer Fees
You will also need to code that freelancer invoice to Prepayments
Example 3: Accrued Income Journal Entry
You offer training to a company, and you raise the invoice after the end of the financial year. That income will need to be accrue to the financial year the workshop happened.
This will require an accrued income journal entry.
Date: End of financial year
DR Accrued income
CR Sales: Training income
The invoice you raise in will also need to be coded to Accrued income
Example 4: Accruals Journal Entry
Your electricity provider invoices you every quarter in arrears. If their invoice spans over the two financial years, you will need to accrue the relevant portion to the year it refers to.
This will require an accruals journal entry.
Date: last day of the current financial year
DR Electricity cost
You will then need to code to accruals the portion of the invoice that is to be allocated to the current financial year.
6) Review your Balance Sheet
The balance sheet is a report that shows you everything that the company owns and everything that the company owes. This includes all your assets (fixed and current), all your liabilities, and any capital or reserves.
Check for any odd amounts that should be investigated. For example, if you took out a loan that you have been repaying, you should expect to see the remaining balance of the outstanding loan at the end of the financial year. If what you see is still the full amount of the loan, it is likely that the loan repayments have been coded incorrectly to another account.
7) Lock the financial year
Once you have posted all the adjustments and are confident that the financial books are correct, you should lock the books on the accounting software. This means that the system won’t allow you to post any more financial transactions that precede the end of the financial year.
This is an important step, as you always want your accounting books to match your submitted accounts. So, you want to avoid mistakenly posting transactions that will change the accounts of a financial year you have already submitted through your Corporation Tax Return.
If you realise that there is a mistake in a closed financial year, you can either start a procedure to amend the accounts, or, if the mistake is not very substantial, you can make a correction in the following financial year.
8) If necessary, seek professional advice.
If your company is small and has a simple financial set-up, you might be able to do all of the above yourself. However, if you are still not quite sure of what you’re doing and you would like the support of a professional, it is absolutely the right thing to reach out to an accountant that can support you along the way.
I recommend using Unbiased to find an accountant that matched your business needs: its search engine will look for the most suitable accountant or financial advisor that can help you with the more technical aspects of preparing your year end accounts.
Other articles you might like
- Capital Allowances for Sole Traders: All You Need to Know
- The Basics of Bookkeeping for Freelancers and Small Businesses
- The Best Free Bank Accounts for Small Businesses