As promised, this week I am talking about account reconciliations. Yes I know, you’re thinking this is one more step that sounds like it takes time or money rather than helping you save time and money. Just let me explain. In an ideal world, account reconciliations should be performed on every balance sheet account (all those assets and liabilities we discuss in the cheat sheet). We don’t live in an ideal world and honestly most small business owners and entrepreneurs can get by with just one key set of reconciliations….cash.
What is a Bank Reconciliation?
Cash reconciliations are also known as bank reconciliations. I know I’m dating myself here, but the easiest way to explain a bank reconciliation is like balancing your checkbook. I don’t personally balance a checkbook anymore but there was a time when I did. I would compare the transaction history for my bank account to my checkbook and the checks I knew I had written. If there was a carbon copy of a check in my checkbook that didn’t show in my account history, I would reduce my bank balance by the amount of that check. This process helped me understand how much cash was actually available at any given point in time.
Performing a bank reconciliation for your business (or the steps your bookkeeper or accountant go through) is very similar to balancing your personal checkbook.
Instead of comparing your bank account to the checkbook, we are comparing your bank account to your accounting records/journal entries.
Why do you care?
There are three important reasons to spend a little time on account reconciliations. Here’s how they really do save you time and money.
Bank reconciliations highlight the transactions that have not yet cleared on a specific account. Just like my checkbook comparison above, your bank reconciliation helps you understand where your cash actually stands at a given point in time. This knowledge, when accurate, can save you from late fees, overdraft fees, and help in proper cash management and cash flow.
Complete and Accurate Records
I know I say this a lot, but the completeness and accuracy of your accounting records is critical for appropriate business making decisions. You cannot make the best decisions for your business if you have unrealistic expectations or inaccurate perspectives of your current position. It goes further than just your cash flow position and ability to pay the bills. It impacts your budget and forecast. It impacts our ability to analyze and adjust. It impacts your ability to grow and scale your business. Growing and scaling the business is ultimately how we get more time and money.
Also known as…someone is stealing your money. Technically, fraud means a lot more than that but for the purpose of this article we are focusing on cash. The fraud risk related to cash is that someone is stealing from the business. I don’t just mean employees or contractors. What if that new vendor you’re using decides to add a zero to the check you wrote them? Public companies are subject to internal controls and independent audits which reduce the risk of fraud. Private companies, specifically small businesses (those with 100 employees or less) are highly susceptible to fraud because they don’t have the time, money, or requirement to go through these steps. According to the ACFE’s 2016 Global Fraud Study, 30% of fraud cases occur in small businesses. 8% of small businesses detect fraud through their account reconciliations. Though these may take more time to perform, they can save you the cost of stolen money and/or litigation for fraud. The median fraud loss for small businesses is $150,000. That’s a lot of money!
Bank Reconciliation Basics
Now we get to the time vs. money part. You can always pay someone to do the bank reconciliations for you. If you do, I still recommend my clients understand the process and review the completed reconciliations. I’ll include a section at the end of this for what to focus on if you are reviewing rather than doing.
1. Gather the Data
Go grab your bank statements (and/or credit card statements) and accounting records for the period you’re looking at. Make sure that period cuts off at the end of the month. You don’t want to be doing this mid-month. If you’ve never done a bank reconciliation, I recommend going back to the beginning of the current year for this process. Once you’ve caught up, the reconciliation should be performed every month or quarter depending on your size and number of transactions each period.
Put your accounting records for ONE bank account side-by-side with the related bank statement(s). The first step is to compare the ending balance on the last/most recent bank statement to the ending balance for the period in your accounting records. They will likely be different. Let’s figure out what’s different. Are there any transactions in the bank statement that aren’t in your accounting records? What about transactions in the accounting records but not the bank statement? Highlight anything that doesn’t exist on both sides (bank statement and accounting record) or doesn’t show the same amount for the same transaction on both sides.
3. Review The Differences
Go through the list of highlighted transactions. Make sure all of these are legitimate business transactions (with receipts, invoices, etc. supporting them). Here are some commonly identified differences and how to handle them.
- Were any of the bank statement transactions personal? That would explain why they aren’t in your accounting records. These transactions can be “corrected” with a journal entry or by reimbursing the cash back to your business. Don’t leave the accounts out of balance!
- Were any of the bank statement transactions at the ATM? Cash withdrawals are easy to overlook and not match to their accounting record/receipt. You (or your bookkeeper/accountant) will just need to make a journal entry to record these in the right period. Don’t forget those ATM fees too!
- Were any of the bank statement transactions just overlooked? It’s not uncommon to forget to hand over a receipt or record a journal entry. That’s why this process is so important! If the transaction is for a legitimate business expense, make the journal entry to put it in the accounting records.
- Are any of the accounting record transactions related to uncleared transactions in the bank? Did you write a check that a vendor hasn’t cashed yet? Maybe you received a check from a customer and forgot to deposit it? These transactions won’t change your accounting records or bank statement. You (or your bookkeeper/accountant) will add them to your list of “reconciling items” that get added back to (or taken away from) the bank balance.
- Are any of the accounting record transactions related to a transaction in another bank account? Did a transaction get recorded to the wrong bank account in your accounting records? If the transaction shows up in your accounting records but you can’t find it in the bank statement, make sure it isn’t sitting in a different bank account. If it is, you (or your bookkeeper/accountant) will just need to make a journal entry to move the transaction to the right bank account on your accounting records.
Once you’ve adjusted your bank balance and accounting records for missing transactions (or transactions not yet cleared), do the ending balances agree? They should. If they don’t, go back through the steps above.
5. Review the Reconciliation
If you aren’t the one actually performing these steps, I always recommend reviewing the results of the reconciliation at least once a quarter. Check for the following things to make sure it was done correctly and makes sense.
- Bank balance agrees with the bank statement
- Book balance agrees with the accounting records
- The difference between book balance and bank balance is explained in itemized detail
- The explanations for the differences make sense with what you know of your recent business activities
If you any of these are missing or seem off…ask. We’re all human and mistakes can happen but you deserve to know you can rely on your records.
That’s it! You’re done! It wasn’t that bad was it? It gets quicker and easier as you nail down your accounting process. The most common difference in established bank reconciliations is the uncleared transactions. You can make the process even faster (and easier) by including check numbers on your accounting records to speed up the matching and identification of missing items. I know a reconciliation takes time to do or money to pay someone else to do but I hope after reading this article you realize why it’s worth it….and in the grand scheme of things it’s really saving you time AND money.