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We’ve all been there. You’re staring at your balance sheet and income statement and nothing makes sense. You know it’s wrong, but you have no idea how or why or what to do about it. Whether you inherited the books like this or were responsible for messing them up doesn’t matter. What matters is getting them cleaned up effectively and efficiently. For that you need a game plan, and we’re going to lay one out for you.
I’ll start by mentioning that I highly recommend engaging a professional early on in your business to help you keep away from situations like this. You have to be careful, though, as it is hard to judge another person’s skills at something you yourself are not great at. Make sure the person has good reviews and call a couple of their references first. After all, this is your financial information we’re talking about. Do not necessarily go with the cheapest person. You will end up paying more in the long run.
Bookkeeping is not rocket science, but I can’t tell you how many hours I’ve poured into cleaning up books for clients whose previous bookkeeper did not know what they were doing. All that to say - whether you decide to use a professional or want to clean up your own books, proceed with caution. The last thing you want to do is make the problem worse.
Ok, I’ll get off my soapbox and give you the info you’re here for now.
Before you do anything else, you need to figure out when the issues started occurring in the books. This will give you a sense of scale for the cleanup project. For this I recommend reviewing the following:
Once you think you know where the problem started, it is time to make another decision. How granular of a cleanup do you need to perform? You can decide to clean things up at a high level using journal entries, or on an individual transaction basis. I usually lean towards the latter for any periods within two full fiscal years of the current date. If you notice issues from before then, the reporting needed for those periods rarely needs to be at a super detailed level, and thus high level adjustments are usually OK.
That said, another thing to think about is the taxes may have already been filed for those periods. If your cleanup is going to make changes to those filings, then you will have to refile depending on how “material” the changes are. “Materiality” is another concept related to “large” above, and is kind of subjective. Consult your CPA to determine if the cleanup adjustments can be made in the current period instead.
In accounting, we call bank statements, credit card statements and other items “sources of truth” because they are external records of exactly what happened in an account over any period of time. One goal of bookkeeping, especially reconciliation, is to match that activity with our books. For any periods you have identified as potentially having issues, or for which the accounts in your books are currently unreconciled, grab the statements for those accounts and organize them locally so that you can easily access them throughout the cleanup process. The hour or so you might spend doing this organization is well worth the time you will save throughout the process.
The following accounts are included in my list of items to reconcile:
Walk through the reconciliations for these accounts one at a time, month by month, until you reach the current period. While you’re looking at the transactions, it is helpful to look at where they are coded and make any adjustments now. For instance, if you see Starbucks charged to Insurance, you can be sure that is incorrect. At the end of each monthly reconciliation review the transactions that were unreconciled to see if they are charged to the right account or potentially need to be moved. For transactions that aren’t reconciled, and need to be moved, I recommend moving them to a holding account. Use the same holding account for all transactions you need more research on so they are all in the same place until you figure out where to put them.
An exception to this is checks that were written by the company to others. It is possible for checks to be written and recorded in the system, but not cashed, and thus not reconciled for many periods. If you find checks like that in your system, and they are not reconciled (i.e. have not cleared the bank) after 90 days, investigate the situation further. It could be the check is a duplicate transaction, was actually void or had payment stopped, or the recipient just didn’t cash it. Whatever the cause, checks are a common source of fraud, so it’s important to figure out what happened.
After walking the reconciliations forward to the current period, you can be pretty sure those account balances are correct. Now review the other accounts on your balance sheet and income statement again looking for any noticeable errors or incorrectly coded transactions. You can go pretty deep on this item depending on how granular you’ve decided to get, but each of the items you reconciled had an offsetting account so if you were reviewing those codings as you reconciled, you should be pretty close now. One exception is adjustments for “non-cash” items like recognizing prepaid expenses. If you are on a cash-basis for accounting you needn’t worry about this particular scenario, but for accrual accounting you should be capitalizing (charging to prepaid expense asset account) amounts you pay today for future periods and reducing the balance of that account each period by the amount you are recognizing in expense. This is usually done through journal entries, and will not hit any “source of truth” accounts.
You can repeat this process as many times as you need until you feel comfortable that the books are correct. Remember to go back to the holding account after you’re done and make sure nothing is left in there. It also goes without saying that it helps to keep the books clean from the current period going forward so you don’t have an ever increasing amount of cleanup to do. That would be step zero in the process - stop the messiness.
There are lots of other, more detailed, reports and Excel pivot table manipulations you use to gain ever increasing levels of accuracy, but that is outside the scope of this article. I am happy to discuss them directly so feel free to reach out if you have questions. I would be remiss if I didn’t mention Scrutinize is designed to find a lot of these types of errors without all the heavy lifting.
For answers to questions you have about this or related topics, schedule your free consultation today.