In the spring of 2020, our company connected with an entrepreneur from New York City. 

He owned a small struggling tech company. He was at our door because -- in his words -- he was "tired of flying blind."

He told me in 10 years of business there wasn't a single point where he truly knew how how his business was doing. 

Fast forward to now.  There's been a 180-degree U-turn at his company:

• He manages operations with excellent financial clarity. 

• The company swung from going backward five figures in 2020 to going forward six figures in 2022. 

• Profits in every division are positive and increasing. 

How did this happen?

Financial Clarity in 2 Steps

The answer is simple and complicated. Here is the simple version:

1. We divided his company into divisions.

2. We helped him carefully "close" each month in his financial records. 

There -- you have the two steps. Article over! 

It's not quite that easy. In this entrepreneur's case, it took untold hours of effort and many months of refinement to get these two steps perfected. 

That's because executing these two steps (especially #2) is complicated. 

Here is a bit of detail on each step: 

Step 1: Divide Your Company Into Divisions

Most business owners, if they give it a little thought, clearly know the segments of their business.

For the NYC tech company, we identified three business lines:

1. Services.

2. Software.

3. Hardware.

Each one of these divisions was totally different, with different expected profit margins.

As you divide your company into divisions, consider these points:

1. Only create divisions for distinct lines with different business models or expected profit margins. For example, if you are growing muskmelons and watermelons, it's unlikely those are two distinct divisions. The costs and profit margins are too similar. Not so if you repair cars and have a parts store.

2. Only create divisions you can track. It's common for business owners to desire detail on a wide array of divisions. However, if getting that detail requires employees to carefully track time across 8 different divisions, is that practical?

3. It's okay to only have one division. Don't create divisions for the sake of having divisions. If you don't have divisions, then there is just one step to clarity!

Step 2: Each Month, Do a Careful "Month End Close"

This is where the majority of small companies fall off the wagon. In fact, many new entrepreneurs don't even know what a month end close is.

This step rests on a key point many entrepreneurs miss:

A Profit and Loss report is only accurate after you've done a month end close.​

Hence, Profit and Loss reports are only accurate 12 times per year. That goes down to 4 times if you do a quarterly close, or one time for an annual close!

I cringe when I see a Profit and Loss report dated "January 1 to February 13." Even big companies with sophisticated finance teams don't have accurate books through a date like February 13.

How do you do a month end close?

Step 1: Enter all transactions and reconcile to statements

This is basic bookkeeping and the easy part. It simply involves making sure everything you spent and received is recorded in QuickBooks (or whatever software you're using). Check your work by reconciling to an online balance or statement as of month end.

Do this for all transaction accounts: bank, credit card and merchant (e.g. Paypal and Stripe) accounts.

Step 2: Enter all "non-transactions"

Wait, whoa! What is a non-transaction?

Non-transactions are the key to an accurate month end close. They are the hill on which true financial clarity lives or dies. (It usually dies!)

Here are common examples of "non-transactions:"

1. Fully-built or half-built inventory not on the books.

2. Work-in-progress that is done, but not yet invoiced.

3. Depreciation of equipment and buildings.

4. Interest accrued on loans but not yet paid.

5. Wages earned by employees but not yet paid (almost every company has this situation at the end of every month).

6. Bad debts not written off.

7. Expenses paid annually (e.g. insurance, software subscriptions, etc.) that need to be divided out across 12 months.

You don't get a bill in the mail for any one of these items. There is nothing to reconcile to. Yet if these entries aren't made, the monthly Profit and Loss report is virtually useless. The owner is flying blind just like the entrepreneur from New York.

In the New York case, they had multi-month contracts that involved down payments to get started. These down payments made some months look great and other months look terrible.

To fix that, we developed a process to look at each contract and recognize only the revenue earned in that month. If a customer paid the company $10,000 upfront, but the job was only 50% done at month end, we only put $5,000 into revenue. The other $5,000 stayed on the balance sheet as "Deferred Revenue" until it was actually earned.

This complicated and time-consuming step was the key to monthly clarity. Not only did it provide clarity around overall monthly profit, but also for the profit by division. Both metrics were completely unreliable without this critical step.

With this new-found clarity, the owner was able to strategically adjust pricing and margins to turn profitability around.

Step 3: Lock down your accounting system and never look back

This massively critical step takes 5 seconds to do, but months to accept. After month end work is complete, set a closing date that prohibits any changes.

Everyone in the company will despise this. But hold firm - it is the key to clarity. If you let people make changes to closed months, you'll never know when the numbers are final and all confidence in the numbers is lost.

Can a company achieve clarity without a month end close?

It's possible, particularly in these situations:

1. Very small company with no payroll.

2. A retail or e-commerce operation with steady inventory (or a system that automatically records inventory on the balance sheet).

3. A company that intentionally creates monthly transactions to make each month complete (e.g. invoices customers as of January 31 for all work in January, and pays employees on January 31 for all work in January).

However, most project-based companies (e.g. construction, manufacturing, and trades), as well as growing companies with multiple employees, cannot achieve financial clarity without a painstaking month end close.

Conclusion

TLDR:

Financial clarity can be gained in 2 steps:

1. Divide your company into divisions.

2. Each month, do a careful month end close.

How do you do a month end close?

1. Enter all bank and credit card transactions.

2. Record all "non-transactions."

3. Put a lock on the month.