A Bookkeeper and Business Owner's Guide to Tidy Financials
A "books cleanup" is more than just a tidy-up; it's a critical process for ensuring your financial data is accurate, compliant, and ready for tax season or investor review. Whether you're a bookkeeper tackling a messy client file or a business owner diving into your own records, following a set of core principles will ensure a successful and complete cleanup.
Here are the 12 most important principles to guide your books cleanup:
1. Establish the Clean-Up Period and Scope
Before starting, define the exact period you're cleaning up (e.g., Q1 2024, or the entire prior fiscal year). A clear scope prevents project creep and ensures you focus on what's most critical. Document this scope and any agreed-upon deliverables. The audit history (if available in the accounting software) can be a valuable tool if you are seeing an error and want to see when it occurred.
2. Verify and Correct Beginning Balances
This is the non-negotiable first step. Ensure your beginning year balances for the cleanup period are correct. If you are starting a new engagement or fixing a previous year's errors, you must reconcile the starting balances for all Balance Sheet accounts (Assets, Liabilities, and Equity) with the final balances from the previous period's tax return or financial statements. Use dated journal entries to adjust any incorrect opening balances. If you see opening balance equity, close it out to retained earnings.
3. Reconcile All Bank and Credit Card Accounts
Account reconciliation is the bedrock of accuracy. Reconcile every bank account, credit card, and loan statement for the entire cleanup period. This ensures that every transaction recorded in your accounting software has cleared the bank and that the cash balance is correct. Bank statement converters can help if you only have access to paper statements and want to upload them into software for reconciliation.
4. Separate Business and Personal Expenses
Strict separation is vital. Review all transactions for personal expenses that may have mistakenly been paid from business accounts (or vice versa). Reclassifying or removing these personal transactions ensures the business’ Profit & Loss statement is an accurate reflection of its operations.
5. Review and Clean Up Undeposited Funds and Clearing Accounts
Often a source of error, these accounts need special attention.
- Undeposited Funds: Ensure this account is only holding payments received but not yet deposited into the bank. If entries have been sitting for months, trace them to ensure they were correctly deposited, and clear them out with appropriate entries. For prior year undeposited funds, create an opening balance equity account to
- Clearing/Suspense Accounts: These should generally have a zero balance. Investigate all transactions remaining in these accounts and reclassify them to their proper income, expense, asset, or liability accounts.
6. Scrutinize Fixed Assets and Depreciation
Ensure that any major purchases (equipment, vehicles, real estate) are correctly recorded as Fixed Assets on the Balance Sheet, not expensed on the Profit & Loss. Verify that the correct depreciation schedule is being used and that depreciation expense has been properly recorded up to the cleanup end date.
7. Review Accounts Receivable (AR), Accounts Payable (AP)
- AR: Analyze the Aged AR report. Identify and write off any uncollectible customer invoices (bad debt) to prevent overstating your assets.
- AP: Analyze the Aged AP report. Verify that vendor bills are legitimate and that there are no old, paid bills still showing as outstanding.
8. Examine Current Liabilities
- Notes Payable: Make sure there is activity on the loan. If not, payments may have been incorrectly categorized in an expense account and will need to be recategorized for principal and interest expense
- Payroll Liabilities: Payroll and associated tax account should zero out and if not using accounting software, ensure that payments are coded to payroll liability rather than payroll expense accounts
- Sales Tax Liabilities: Ensure settings and taxing authority is correct. Do not make changes during the tax filing period if already filed – make an amendment to that period or an adjustment in the current period.
9. Equity
- Personal transactions using business accounts should be recorded in the property equity account
- Capital contribution should be capital paid in
- Money out is not an expense and should be coded to shareholder distribution or owner draw, depending on business structure (i.e., corporations vs. LLC & Sole proprietors).
10. Document Every Adjustment
Maintain a clear, detailed log of all journal entries and material adjustments made during the cleanup. This documentation provides a clear audit trail for the business owner, tax preparer, or any future bookkeeper, explaining what was changed and why. For transactions that might be duplicates or appear to be errors, do not “delete” the transaction; use “void.” The audit history in the accounting software can be useful if you need to clarify the transaction.
11. Classify Transactions by Tax Requirements
During the cleanup, ensure sales and expense transactions are classified with future tax filing in mind. This involves confirming sales tax is handled correctly, contractor payments are categorized for 1099 reporting, inventory items categorized as cost of goods sold, all sales and expenses are grouped according to common tax categories, and expenses greater than $2500 are examined to ensure they are categorized as a fixed asset rather than an expense, if appropriate.
12. Implement Future System Improvements
A cleanup is a post-mortem for past mistakes. Once complete, hold a brief review to identify why the books got messy in the first place. This is the time to recommend and implement process changes, such as new receipt capture software, clearer chart of accounts usage guidelines, or a stricter expense approval process, to keep the books clean going forward.
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