Bank reconciliation is a critical process that helps ensure the accuracy of financial records by matching accounting records with bank statements. Businesses that fail to conduct regular and accurate assessments of their bank account balance risk inaccuracies, financial losses, and other data entry errors that can negatively impact their credit control processes.
This blog discusses the importance of bank reconciliations and how they can prevent costly errors as well as the negative impacts doing it wrong can have on your business's credit control process. It also provides a step-by-step guide on how to conduct accurate reconciliations of your bank statements and bank account, along with tips on how to avoid common errors (such as omitting bank fees). Whether you're a small business owner or a finance professional, understanding the importance of bank reconciliation is essential for maintaining financial health and supporting business success.
What are bank reconciliations?
Bank balance reconciliation ensures accurate financial records by matching accounting records with bank statements. It seems simple, but bank reconciliation can be complex and time-consuming, especially for businesses with multiple clients and a busy financial cycle.
The process involves comparing the incoming and outgoing amounts of money in an account with bank transactions to ensure that they match the recorded bank balance. This helps identify errors on your balance sheet, discrepancies in interest income, and fraudulent activity that could undermine business goals if left unchecked. Ideally, the reconciliation process avoids differences between the cash balances on your records and the ending balance on your account statement.
(A bank reconciliation statement is a document that records this process. It shows cash balances held in accounts and how they differ from official company records. If the bank statement ending balance shows a discrepancy, it could mean an error in how you are recording financial information).
For small and medium-sized businesses, bank reconciliation over shorter intervals is essential, as it can help identify and correct mistakes or discrepancies in real time, preventing potential financial losses. Numerous apps and computer systems are available to automate the bank reconciliation process. However, some managers are hesitant to use them due to concerns about sensitive customer data and internal records. Nevertheless, utilizing these systems can be beneficial as long as the appropriate security measures are taken to protect the business's interests.
To ensure your company's accounting process is accurate, you must learn the basics of bank reconciliation and understand the importance of conducting the process correctly. Failing to do so could result in inaccurate financial reporting, which could ultimately damage the business's reputation and financial standing. Furthermore, accurate reconciliation is also crucial in the credit control process to maintain financial integrity and enable effective financial decision-making.
Lastly, the software can also assist with bank reconciliations that apply to two cash balances (for businesses with multiple accounts). These features help to keep control of more complex money flows.
How to do bank reconciliation
The first step is to reconcile your bank statements and gather all relevant documents and records of transactions, such as receipts, invoices, and other documentation of expenses and income. Make sure that all bank records are complete, accurate, and up-to-date. Ensure they contain all necessary information, including interest income, outstanding checks, and bank fees, as these are essential for reconciling your bank statements.
Next, compare the records of cash transactions with the bank statement. Look for discrepancies between the two, such as missing or double entries, and identify the reasons for the discrepancies. For instance, timing differences in your bank account, bank service fees, errors in recording bank transactions, or cash flow timing, are all common reasons.
Once you've identified the discrepancies, you need to make adjustments to the records of transactions to match what your bank statement shows. This involves reconciling the cash balance in the records with the bank statement balance and taking into account any outstanding checks, deposits, or other transactions that have not yet cleared from your cash account.
It's essential to document all adjustments made during the bank reconciliation process to ensure accuracy and transparency. This documentation can be used for audits and other financial reporting requirements. Furthermore, it can also help discover fraud or accounting errors. For instance, you can look for unusual transactions and generate an estimated value of your bank deposits based on previous account activity levels.
Finally, after making the necessary adjustments, you need to update your records of transactions to reflect the reconciled bank account balance. This will help ensure that your company's accounting records are accurate and up-to-date, enabling you to make informed decisions about your business's finances and generate more accurate reporting.
Once you finish the bank reconciliation process, your adjusted bank balance should equal your adjusted cash account balance. Unfortunately, you may still arrive at two cash account balances that differ. For example, the cash book balance can sometimes be more than the cash account balance, or the other way around.
When this happens, it means a discrepancy remains between the cash account and the cash book. At this juncture, you will need to be forensic, looking for the source of the discrepancy, whether an error made by your financial institution, outstanding checks, or something else.
Reconciling bank statements comprises a critical set of processes that should be done regularly and accurately to ensure the financial health and stability of your business. Fortunately, with the right tools and knowledge, you can make it manageable and efficient, saving you time and money in the long run.
Why is it important to reconcile your bank statements?
Bank statement reconciliation is important because it helps businesses note bank errors and their own mistakes. Even with the most reliable bank and vendor systems, missteps can still happen. For instance, you may get charged twice for a purchase, be charged a fee that you were not aware of, or be a victim of fraudulent transactions.
If left unchecked, these errors and activities can accumulate and negatively impact your business's finances. By conducting regular reconciliations of your bank account, you can quickly spot and rectify any mistakes or discrepancies before they become bigger problems.
In addition to avoiding costly errors, bank reconciliation statements can also help you better understand your business's financial health. When you know how much money is coming in and going out of your accounts, you can make more informed financial decisions that align with your business goals and objectives. For example, cash flow could be improving while interest income is falling.
Furthermore, keeping accurate and up-to-date records through bank reconciliation can also make it easier to prepare financial statements and tax returns. This can save you time and money in the long run, as well as help you avoid any penalties or fines for inaccurate reporting.
In short, conducting regular bank account reconciliations is crucial for maintaining accurate financial records, avoiding costly mistakes and fees, and making informed financial decisions that support your business's success. Ideally, these should match the bank's records.
How poor bank reconciliation can negatively impact your business's credit control process
Bank reconciliation plays an important role in the credit control process. Reconciling your bank accounts can prevent your business from making losses from fraud and even erratic filings when you're unable to track your expenses. It‘s these negative impacts that usually push most businesses to evaluate how they handle their accounts during operations to avoid costly bank statement-related blunders.
Some common problems that can arise when bank reconciliation practices are not followed include the following:
If not done correctly, you can be chasing invoices that have already been paid
When doing bank reconciliations, you usually match cash balances on your accounting system with the corresponding amounts on the bank statement. In the process, you determine the differences between the two elements to make changes to accounting records. You must check the beginning cash balance against your expenses to determine whether the figure is correct.
But when the way you reconcile your bank is incorrect, you might find yourself chasing invoices that have already been paid, which might be a waste of resources and confusing for clients. An instance where you ask a client for payment, they've already sent the wrong signals, even suggesting that you're trying to defraud them. It is important to do bank reconciliation correctly to match what you have in your balance sheet with the reality in your receipts.
It is also critical to avoid data entry errors. While monthly bank statements are usually accurate, you may make mistakes translating between cash receipts and your own records. Even your financial institution could make a mistake. Bank error is uncommon, but does occur.
Payments misallocation leads to chasing the wrong invoices
Sometimes, you can find yourself chasing individual invoices that have been paid already, and in other cases, the wrong invoices show up in your accounts receivable. This is a common concern with the bank statement reconciliation process for small business owners, where double entries can create discrepancies and confusion in the corresponding account. When a payment or invoice is categorized incorrectly, it might become an overlooked amount that will affect your credit control process.
For example, failure to account for one invoice in a transaction can create another discrepancy that usually matches the overlooked entry. These costly mistakes make your bank statement reconciliations an important step in realizing an accurate credit control process that is crucial for your business' margins.
The account reconciliation process is also essential for maintaining good relationships with customers. Ensuring your financial statement matches your accounting records prevents you from harassing clients for money they don't owe (and putting them off from using you in the future).
Misalignment in customer/supplier statements
When dealing with many customers or suppliers, following proper reconciliation guidelines can be time-consuming. In this instance, the reconciliation considers the intricate details of the invoices, discounts, payments made, and even advance payments. When done poorly, bank reconciliation can create misalignments in customer and supplier statements. Adjusted balances could be significantly inaccurate on your accounts payable and receivable.
You can also miss out on adjusting journal entries to modify the cash account in your general ledger. Failing to do so could mean you could misrepresent your cash balance
Proper reconciliation can ensure that you're able to not only confidently identify payments you made but also those that the supplier failed to note in their books. A bank reconciliation statement can also accurately take note of any discounts and reduce overpayments to the supplier, which is good for your overall profit margins. By taking advantage of automated solutions, you can avoid all the hassles of processing individual accounts and making avoidable mistakes that affect your credit control process.
Inaccurate tax reporting
Reconciling your bank statements incorrectly could also lead to accounting errors and prevent you from completing accurate tax reporting. Failing to match business transactions to a statement could stop you from making the correct tax return, even if you provide your accountant with all your company's cash records.
Monthly bank reconciliations help to prevent this. Both you and auditing tax authorities can feel confident that all financial information is accurate.
Bank reconciliation is crucial to your credit control process
If your business deals with many customers and suppliers, reconciling your bank statement with all your transactions is essential for credit control. Furthermore, protecting your finances requires monitoring clients' credit limit status, ensuring they have sufficient funds, and, sometimes, taking corrective action.
To handle the realities of credit control, businesses adopt different approaches to bank account reconciliation, including defining credit control policies, building relationships, and maintaining a watchlist. If your business needs to streamline its credit control process, tapping into the many advantages of bank reconciliation is a great way to avoid hassles.
Chaser helps businesses by providing a reliable accounts receivable solution that can track and send automated payment reminders when invoices are overdue. Chaser's users, like LoveBrands for instance, use Chaser to automate their accounts receivable process, without losing the human touch. As a result, they now save 15+ hours per week on their credit control activity.
Practically speaking, when the bank reconciliation in a business's accounting software is not done correctly, clients can end up chasing the wrong payments. By contrast, when businesses do their reconciliation accurately, they can avoid unnecessary blunders and refine their processes to ensure that they always remain profitable.
