If you’ve finally made it to the end of an accounting period, it’s important to close your small business’ general ledger in preparation for the next period.
Closing your general ledger is a preceding event for the end of the fiscal (tax) year. This gives investors, banks and the owners detailed information regarding the performance and growth of the company throughout the year.
As well as this, it also helps the business to prepare to pay corporation tax and make claims for tax relief and tax deductions.
Why do I need to close my general ledger?
The primary reason for closing a general ledger is to close off one tax year and prepare for another.
The most important step in this process is to clear outstanding balances across each account that should not be allowed to transfer into the next accounting period.
An important side-note: your cash or inventory balance should remain the same. Revenue, income and expense accounts, however, should start from zero in the new period.
Balancing your account allows HMRC to measure how much tax you should pay over the fiscal year. This is dependent on your company’s net profit for that fiscal year.
In order to do this, you subtract your expenses from the revenue for the given period. This is why it’s important to reset these values to zero for the new financial year – otherwise there could be confusion over financial data.
Let’s imagine that you fail to clear your revenue account and, as a result, the financial data for the following tax year implies that your business is doing worse than it actually is. Your company may make business decisions based on wrong information, which could negatively affect the healthy success of your company!
Returning the revenue’s and expense’s accounts balance to zero is the main priority – if this is done incorrectly, the business will not have an accurate idea of how the company has performed.
Closing your general ledger properly is an important part of the accounting cycle.
So, how do you go about closing a general ledger?
Closing a general ledger can be more complicated than it sounds, especially keeping track of which accounts should be temporary and which are permanent.
Permanent or real accounts transfer their balance to the next period. They do not get reset to zero for the new financial year as the accounts include more permanent fixtures of your business such as assets and liabilities.
As these two are permanent, that means the equity value is also permanent and transfers across to the new fiscal year, maintaining its previous value. This is because of the accounting equation, the foundation of the double-entry bookkeeping method. The accounting equation is as follows:
ASSETS = LIABILITIES + EQUITY
So, if assets and liabilities retain their value, then equity must also!
Temporary or nominal accounts refer to those closed at the end of the fiscal year. Company dividends (profits returned to shareholders), revenues and expenses make up these accounts.
Closing these balances at the end of the year allows accountants to provide accurate financial data for the growth and profit of the business over the fiscal period.
Temporary accounts tend to give a picture of the activity of the business, how it has performed, where it has made money and how it has operated on a day-to-day basis. Permanent accounts, on the other hand, demonstrate the spine or foundation of the company.
What next?
So, in closing the accounts for the elapsed accounting period, the accountant will create an income summary for the temporary accounts.
The summary of your revenues and expenses for the fiscal year is equal to the balance of the account, which tells the business whether they made a profit or loss over the accounting period. This balance then gets transferred to a retained earnings account.
The retained earnings account is equal to the net income of the business, minus the dividends paid out to shareholders.
Once the balance of the revenue, expense and dividend accounts are transferred to the retained earnings account, the balance is reset to zero in preparation for the new fiscal year!
We here at Count can’t underestimate the importance of maintaining accurate financial records. It can help give you a real idea of how your business performs, what it does right and what it might be doing wrong.
Take a look at the rest of our guides for more information on the basics of bookkeeping. Or, if you’re interested in hiring one of our professional bookkeepers, you could chat to one of our expert advisers.