Imagine applying lean principles to the most common batch-process in most offices; the monthly financial close. While it may seem like lean principles could never be meaningfully applied to such a quantitative and seemingly foundational business process that couldn’t be further from the truth. In fact, many lean organizations reduce their month-end closing activities to a single day, while maintaining accuracy and significantly improving the efficiency of their closing process.
Cost of Closing
Many companies take days or weeks to close their accounting books and prepare financial statements every single month. Amazingly, some organizations don’t even complete these activities until the middle of the following month! Consider how costly this would be for a business. How much are closing activities costing your business?
Fortunately, the cost of your organization’s closing activities can easily be estimated with a fairly simple process.
To figure out how much the monthly close is costing your business start by making a list of every person involved each month in closing the books and producing financial statements. Note the day during the duration of the closing window that they actually begin assisting in the closing process. Also note the deadline for financial reports to be complete. Refer to the example below (Table 1).
Table 1: Calculating the Cost of Closing
Based on the example data in table 1, Mary started helping on Day 4 of closing the books. Because the deadline for completing reports is Day 10, every month, Sally works on closing the books for a total of 6 days.
From this, you can easily see the number of days it takes everyone to end the audit every month. As can be seen in this example it shows a total of 36 days per month are needed to close the books. This translates to 432 days annually.
For U.S. organizations with a Monday to Friday workweek, there are roughly 260 working days each year. Thus, for a team of 6 people that equates to a combined total of 1,560 available working days.
Thus, 27.7% of the team’s total available annual working time is spent closing every year (27.7% = 432 closing days / 1,560 available working days).
To determine the total financial cost for your team to close the books, you may reference each team member’s actual salary or, if privacy is a concern, you could simply apply the team’s average salary to each individual. The final total will be the same.
In this example you can see that the team spends a total of $6,231 of their time every month on closing the books for a grand total of $74,769 per year.
Unfortunately, the sizable investment isn’t the worst of it. The real tragedy is that the investment is in gathering data that are most probably outdated by the time it’s analyzed and shared with decision-makers. Whether the output justifies the sizable input is something that your organization will need to determine for itself. If it doesn’t, then leaning out your closing process may be called for.
Lean Closing Tips
The simple, but powerful closing tips below are intended for you to be able to significantly improve the speed and efficiency of your month-end closing process. Obviously, each organization is unique. Think of these tips as general principles to be applied to the best of your organization’s ability. Also keep in mind that just as lean facilitates the continuous improvement journey, these lean closing tips may be applied in an iterative fashion.
- 1. Fix the problem not only the numbers.
Mistakes happen. Unfortunately, many organizations waste far too much time correcting the previous month’s books without ever investing the time necessary to adequately resolve why a correction was needed in the first place. In lean organizations, everyone should be collaborative problem-solvers that welcome root cause analysis any time there’s a mistake that needs to be corrected. By systematically identifying the root cause of mistakes and implementing appropriate countermeasures you can drastically reduce the amount of time spent on the closing process over time.
- 2. Small amounts can wait.
Many journal entries can be attributed to corrections related to insignificant amounts that don’t provide data helpful for better decision making. It’s incredibly important to remember, in line with the principle of materiality, your organization is not required to report discrepancies too minuscule to matter.
- 3. Move transactions outside of the closing window.
As much as possible, encourage transactions to occur outside of the closing window. While there are things such as income taxes which can’t be completed before month end, there are often many transactions that can be executed outside of the closing window such as appreciation and payroll.
This concept is similar to the lean manufacturing principle of the Single Minute Exchange of Dyes (SMED). The concept of SMED is to maximize the amount of machine changeover work possible before the equipment ends a given production run. In our case, the closing process is similar to a machine changeover. The more activities that can be completed before the end of the month the less time can be spent on closing after month-end. Once that has been achieved, as in manufacturing, you can focus more effort on improving those activities that can only perform after month-end (e.g. after the machine has stopped).
While this describes the spirit of SMED, unfortunately, the systematic application of SMED is outside the scope of our discussion, but definitely worth further review if you’re unfamiliar with it.
- 4. Prioritize accuracy over precision.
While being both accurate and precise is preferred, it is never sensible to invest the additional time and effort to produce precise numbers that won’t impact decision making. For example, to report something at 29.63% is certainly very accurate and precise. While 30% is not as precise, it’s certainly accurate. Unless decision making will be meaningfully impacted by the additional precision then additional effort should not be invested to produce that precision.
The matching principle requires organizations to present a forecasted warranty expense whenever merchandise is shipped. While projecting warranty expenses can consume large amounts of time, the estimate doesn’t significantly improve the decisionmaker’s understanding of the company and product performance.
That said, why not simplify the warranty estimation process by using last year’s ratio of warranty costs to sales. You can now multiply each given month’s sales by this percentage to approximate the month’s warranty costs.
You could further improve this process by moving the warranty estimation outside of the closing window by referencing the sales for each day of the month except the last day. For the final day’s sales, you can employ an acceptable method based on previous sales trends.
Remember, that this is just an estimate so don’t obsess over precision. Instead, routinely review the numbers to ensure that they continue to be accurate. Don’t be surprised if this demands making the occasional changes to the ratio. Just remember that complex, time-consuming calculations don’t automatically improve decision making. By keeping things simple things are made easier and more efficient for everyone.
- 5. Routinely review closing transactions.
Lastly, you want to continually review those transitions and activities that occur at closing. Ultimately, you should allow the process owners to determine whether their tasks are value-added to avoid needlessly offending them, inadvertently undermining morale, and future continuous improvement efforts.
As your organization improves the efficiency of its month-end process, it’s also very important to continually ask yourself whether closing our books on a monthly basis is even necessary. That’s not to suggest that the process brings no value at all. Perhaps it doesn’t bring any value. However, it’s much more likely that it delivers less value than blindly assumed. It’s quite possible that the only real value it delivers is celebrating monthly wins or the information may be utilized in strategic decision making.
Regardless, don’t lose sight of the principle that supplying visual feedback to decision-makers should ultimately be a daily activity. Thus, don’t feel obliged to wait until month-end to make necessary improvements to your organization’s accounting and financial reporting processes.
This concludes our introductory series on lean accounting. We hope your organization finds it helpful on its lean journey. For more on the topics of lean manufacturing, inventory management, and supply chain optimization check out Falcon’s blog and Lean Learning Center.