What is bank reconciliation, & Why is it important?

Introduction:

A general ledger tracks a company’s cash transactions, while a bank statement records money flow in and out of its account. Ideally, these two should match perfectly, but that’s rarely the case. This is where bank reconciliations come in. It’s a process that ensures your recorded transactions align with what happened in your bank account.

But why is this process so important for business owners? It can protect you from financial errors, fraud, and even unnecessary stress. In this blog post, we’ll explore the bank reconciliation process, break down its different types, and highlight the major benefits that help you manage your finances more confidently.

What is bank reconciliation?

Bank reconciliation is the process of matching your bank statement with your cashbook to check if the balances are the same. This helps you confirm that your financial records are correct and up-to-date.

Sometimes, the balance in your cashbook will not match the bank statement due to the following:

• Cheques not cleared: These are cheques that you’ve written and recorded in the cashbook, but the recipient hasn’t deposited them yet, or the bank hasn’t processed them.
• Deposits not yet credited: These are payments you’ve made into your bank account, but they don’t appear on your bank statement because the bank is still processing them.

These differences are known as reconciling items because they help explain why the balances don’t match. Other differences may come from transactions shown on the bank statement that haven’t been added to your cashbook yet. These might include:

• Direct debits: Payments that the bank makes on your behalf to another party with your approval.
• Standing orders: Regular, fixed payments that the bank automatically makes on specific dates.
• Bank charges: Fees that the bank takes from your account for its services.
• Interest: Money that the bank adds to your account as interest on your balance.

How often should businesses reconcile my bank statements?

How often you reconcile your bank statements hinges on the number of transactions your business handles.

For instance, a manufacturing company that manages numerous daily purchases and sales should reconcile their accounts daily to ensure all transactions are accounted for. Similarly, an e-commerce platform experiencing constant order processing and refunds would benefit from daily reconciliation.

On the other hand, a local consultancy firm with sporadic client payments might find weekly or monthly reconciliation adequate.

Maintaining a regular reconciliation routine simplifies the process. Delaying reconciliation for several months can lead to a daunting backlog of transactions to review.

Types of bank reconciliation

Here are the different types of bank reconciliation:

Manual bank reconciliation

Manual bank reconciliation involves physically reviewing and comparing the transactions recorded in the company's accounting records with those listed on the bank statement. Accountants or finance personnel manually check each transaction, including deposits, withdrawals, and fees, to verify their accuracy.

This process requires going through both sets of records line by line, identifying discrepancies, and resolving them one by one. While manual reconciliation can be thorough, it is time-consuming and more prone to human error, particularly for businesses handling large transaction volumes.

Automated bank reconciliation

Automated bank reconciliation is a more efficient approach that leverages accounting software to streamline the process. Transactions from the bank statement are automatically imported into the company’s system and matched with the internal accounting records.

The software quickly identifies matches and flags discrepancies for review. This method reduces the manual effort involved and minimises errors, allowing finance teams to reconcile accounts much more quickly. The use of automation also provides timely updates, making financial reporting more accurate and simplifying the identification of inconsistencies.

Electronic bank reconciliation

Electronic bank reconciliation takes automation a step further by using electronic data interchange (EDI) or other electronic banking methods to match transactions between the bank and the company's accounting system.

This advanced method allows transaction data to be transferred directly from the bank to the company’s financial software. It is particularly useful for large organisations with multiple accounts or a high volume of transactions. By using electronic methods, companies can quickly detect discrepancies or errors without the need for extensive manual oversight.

Manual Bank reconciliation process

To complete a thorough reconciliation, follow these key steps:

Examine the bank statement

Begin by carefully reviewing your bank statement. This step involves identifying any inconsistencies or transactions that haven’t been recognised, such as deposits, withdrawals, fees, or other charges. If any unprocessed cheques or transactions exist, it can make it difficult to compare the bank’s figures with your internal financial records.

Cross-check with internal records

After reviewing the bank statement, compare it to your internal financial records. This includes checking your cash book, cash balances, and accounting entries. Pay attention to any discrepancies, such as outstanding cheques that haven’t yet been reflected in the bank statement or deposits that are still being processed. These timing differences often explain mismatches between the bank’s balance and your own.

Update your internal records

Once you’ve identified any differences, adjust your internal accounting records accordingly. For instance, if you have deposits that haven’t yet cleared, they should be noted in accounts receivable to ensure your adjusted balance aligns with the bank’s records.

Final reconciliation of accounts

After all adjustments are made, the final step is to reconcile the balances. This involves ensuring that your internal records now match the bank’s figures after considering all transactions for the period. Completing this process accurately will ensure your accounts are balanced and up to date.

Why is bank reconciliation important for businesses?

Here are a few reasons why reconciling your bank statements is so important.

Helps you spot bank errors

Even though banks are typically precise in their operations, errors can still occur occasionally. These errors can vary from simple misreads to significant mistakes that could affect your account balances.

For instance, a bank might incorrectly process a check, either adding an extra zero to the amount or placing a decimal point in the wrong spot. Such errors could lead to your account being overcharged or reflecting an inaccurate balance. Catching bank errors early prevents them from impacting your overall financial standing and helps maintain the accuracy of your business’s account balance.

Helps you spot fraud

Regular reconciliation makes detecting fraud in a small business much easier. By comparing your bank and transaction statements with your internal records frequently, you can quickly spot inconsistencies. Fraud can take many forms, and staying consistent with reconciliations helps you remain vigilant and catch potential issues early.

One common type of fraud involves employees misusing company resources. For example, an employee might use their company expense account or corporate credit card to make personal purchases that have nothing to do with business operations. Without frequently reviewing the records, these unauthorised expenses could go unnoticed, potentially draining company resources over time.

Similarly, fraud can occur with payments, such as a vendor tampering with checks by inflating the amount they are paid. Vendors might also manipulate electronic payments to their advantage, possibly altering payment details or amounts to extract more money than agreed upon. Regular reconciliation of your bank records with your internal accounts helps you catch these issues early and prevent financial losses.

Helps in managing accounts receivables

One frequent source of reconciliation discrepancies is tracking receivables, particularly when customers pay via cheques or delayed payment terms.

Sometimes, a cheque might bounce, or a payment may not clear as expected, causing a gap between your internal records and the bank statement. reconciliation helps you detect these issues early, allowing you to follow up with the customer or vendor to resolve the payment.

If the payment remains unsettled after multiple attempts, you can choose to write it off as a bad debt. This keeps your financial records reliable and properly maintained.

Helps in tracking bank interest and fees

Another important reason to perform bank reconciliation is to stay on top of any interest payments, fees, or penalties the bank may apply to the account. These amounts can sometimes be overlooked if the business does not reconcile its accounts frequently.

If they are not tracked, this could lead to differences between the company’s financial records and the actual bank statements, creating confusion at the end of the accounting period.

By carrying out reconciliations regularly, the business can ensure that its records are updated to include all the relevant charges and adjustments, leading to more accurate financial reporting and fewer surprises when it comes time to balance the books.

Helps you to gain financial control of your company

Bank reconciliation enables you to gain explicit financial control by providing an accurate view of your company's economic situation. With a solid understanding of your actual cash balance, you can make well-informed decisions about when to invest, when to save, and how to allocate funds for growth.

For instance, if your bank reconciliation shows that after accounting for all expenses and fees, you have $15,000 available, you can confidently decide whether to invest in new equipment or hold onto the cash for operational needs.

This also helps you plan how much revenue is necessary each month to meet expenses and increase profitability. By maintaining this level of financial clarity, you can ensure your company is on a stable growth path and well-prepared at the end of each financial period.

Conclusion

Accurate bank reconciliation is vital for maintaining balanced financial records and preventing issues like missed payments or fraud. If managing reconciliation yourself is time-consuming or stressful, consider hiring a professional bookkeeper.

At CleanSlate, our dedicated bookkeepers simplify the most challenging aspects of reconciliation by automating the tracking of settled orders, fees, and chargebacks. This ensures that these transactions are accurately recorded in your general ledger. By eliminating the need for manual excel workbooks, our solution reduces errors and speeds up the entire reconciliation process, making it easier to manage your finances.

So, if you’re tired of juggling bookkeeping tasks and want someone to manage it all – including the bank reconciliations – get in touch with us now. We’ll make bookkeeping stress-free for you.