The Fast Close, Part 1 (#16)
/In this episode, we introduce the concept of the fast close, where the financial statements are produced on a vastly accelerated basis, usually in a single day.
First, I’d like to point out my background in this area. I’ve been issuing financial statements for about 20 years now, and noticed early on that producing financials took a painfully long time. In many cases, it took us a month to issue financials, so we were right back at it the next day, doing the next month’s financials. Since doing the financials all the time meant that we were not doing other things, this struck me as being a waste of time. Also, in a few cases, we had a financial crisis on our hands and didn’t even know it, since it took so long to find out how we had done.
Over a number of years, and with several different companies, I figured out on my own how to shrink the closing interval to just one day. There really have been no guidelines anywhere about how to do a fast close, so I gradually built up a list of what worked (and what did not work). The result is that, for quite a few years now, I’ve been putting out 16-page financials for a multi-division company in one day. For the year-end financials, we always schedule two days to close the books, just because the books will be audited, and we want to be extra careful. However, even then we almost always finish up on the first day, and we’re pretty much sitting around twiddling our thumbs on the second day. So, that’s my background on this topic.
Define the Fast Close
Also, let’s define the fast close. It means that you can release financial statements really fast, preferably in a single day. I suppose an alternative possibility is to have a “faster close,” which means anything quicker than what you’re doing now, though slower than a single day. There is also something called a “soft close,” which means that you don’t really issue a full set of financial statements – instead, you just pull statements from your accounting software without going through all the accrual and reconciliation steps that are normally needed for a complete close.
What you get is financial results that are not entirely accurate, but the effort required to get there is pretty minimal.
The soft close is most commonly used by public companies who only have to release quarterly results, so they run a soft close on the other 8 months of the year, just to get an idea of what kind of results they’ll be reporting at the end of the next quarter.
The Need to Spread Out Closing Activities
Now, the single most important solution to the whole closing process is fairly simple, once you define what the problem is. The main closing problem is that you have to jam way too many closing activities into too small a time period. So, with that problem definition in mind, the solution is – to move closing activities out of the closing period. What I mean is, rather than trying to complete perhaps 30 closing activities on the first day of the month, just figure out which items really need to be done on that day, and shift most of the other activities out of that one day.
I’m going to give a bunch of examples on this topic. First, let’s say that you always wait until closing day to create a payroll accrual for unpaid wages from the preceding month. This one can be difficult, because you want to wait for all timesheets to be submitted, so you can create a really accurate wage accrual. However – most of those wages can be easily predicted, since most everybody works an 8-hour day, and you already know which days from the end of the last month have not yet been paid through the payroll system. So… multiply the number of wage earners by 8 hours per day, by the number of unpaid days, and there is your wage accrual. No need to wait until after month-end to calculate that.
Now, you may not like to do this, since somebody will probably work a few hours more or less than the average during those unpaid days. Sure. Absolutely. But by how much will you be off? Probably by not very much at all. And if you want to be more accurate by estimating a little overtime for those people who usually work it – then fine, add it to the accrual. My point is, that the wage accrual is not that hard to calculate with a fair degree of accuracy before the month has closed. One time, I created a wage accrual three weeks in advance, and then compared it to what the actual expense was, and I was only off by a few percent – and certainly not enough to make much of a difference in the financial statements.
Here’s another example. What about the bad debt reserve? A lot of people adjust it on closing day, based on their review of the aged receivable balance on that day. Great, that’s one approach.
But it takes up precious time during closing day, and don’t forget that the goal is to move everything possible out of closing day. So, why would your reserve be any less accurate if you updated it a few days early? After all, it’s a reserve – it’s not intended to be absolutely accurate, and you are allowed to be a little bit off. So – work with your credit manager, and make your best guess. Chances are, your best guess a few days early will be about the same as your best guess on closing day.
Here’s a third example. The real fear of most controllers is that they complete the financial statements on closing day, and then find out that they contain some errors. And those errors take up a lot of time to investigate and correct. So. Why not review the financials for errors a few days early, and fix them as soon as you find them? By doing so, only the transactions entered in the last few days of the month still might contain errors, and that should vastly reduce the amount of error fixes you need to take care of on closing day. And another point on this – if you spot an error in the financials a few days early, this is not a rush period, so you can relax and take your time to properly fix whatever caused the error. By contrast, if you spot an error on closing day, it’s very likely that you’ll blaze through the investigation as fast as you can, and quite possibly throw on a short-term fix that doesn’t really halt the underlying problem. So, earlier problem resolution gives you better solutions. And on top of that, you just took a lot of difficult work out of closing day.
Here’s a fourth example. What about depreciation? Most people like to wait until all accounts payable have been recorded for the month, and then figure out which ones are fixed assets, and then record their depreciation. I don’t do it that way.
Instead, I record depreciation a day or two before the end of the month, based on two sources of information. First and most important, I use all accounts payable that have been recorded so far in the month. This means that I may miss a fixed asset for which the bill arrives in the last day or two of the month. The second source of information cover this problem, because I also use the purchase order that we issued from our capital budgeting system for any fixed assets that should arrive before the end of the month. Between these two sources of information, I can create a pretty accurate depreciation number before the month is even over.
And furthermore, what if I miss the depreciation on a new asset, or miscalculate the amount? Well, think about this for a minute. A typical asset is depreciated for a minimum of three years, if not longer. So, even if my depreciation calculation is off, then – worst case – I’m only off by 1/36th of the total asset amount. And, if this kind of error occurs, I can correct it at my leisure at any point during the following month. Quite honestly, I can’t even remember when I’ve needed to make such a correction, because the system works pretty well, and the depreciation figure is accurate.