As a business owner, you may wonder, why it is crucial to reconcile your bank statements. To put it simply, reconciling your bank statements keeps the finances of your organization in order, and even though it may seem easy, it can actually prevent you from various types of crises.
In today’s article, we will talk about why it is crucial to reconcile your bank statements, what it can protect you from, what are the benefits, and whether are there any challenges to it.
Let us first find out what a bank reconciliation is all about.
What is a Bank Reconciliation?
You compare your bank statements to the financial records of your business when you perform a bank reconciliation. You can identify any possible differences between your bank’s records and your own by doing this.
In this way, you can be certain that no money “goes missing” from your accounts in this manner. Furthermore, this extends beyond your primary checking accounts to include any credit cards and transaction accounts you may have (such as PayPal).
How does Bank Reconciliation Work?
Bank accounts must be reconciled on a quarterly basis or a monthly basis. While doing it, you can authenticate that your business transactions or individual transactions match your bookkeeping. There are two feasible ways to do it:
Analytics Review
If there is any fraud or accounting inaccuracy in your accounting records, you can find out with an analytics review. For example, suppose that each year you make the same purchases, but this year the balance sheet indicates that you spent significantly more than you had planned.
It is possible to determine whether or not there were problems by comparing past account activity levels with purchases. One possible reason for the issue with the amount could be that the bookkeeper accidentally put an extra zero at the end of the payment.
Documentation Review
When you are opting for documentation reviews, you are comparing your monthly transactions with those that are linked to the equivalent amount.
Why do you need to Reconcile Your Bank Statements?
Any business that wishes to maintain proper bank accounting must have a bank reconciliation statement. The following advantages can result from monthly bank reconciliations:
- Business Financial Status
Bank reconciliation statements can point out where your particular business is. For instance, in case your bank statement balance does not match your accounting records, you may eventually pay more than what you have.
Any bank reconciliation statement can assist you in identifying any possible bank service or interest income that you do not know. In this way, you will learn that the bank balance of your organization is actually precise.
- Identifying Bank Errors
Even though they are uncommon, banks can make mistakes. Bank reconciliation can be quite beneficial if there are differences between your records and the bank records. Speak with a bank representative if you are unable to determine why those mistakes occurred.
- Fraud Identification
Even though the bank reconciliation may not be able to stop the fraud from taking place, it will let you know when it happens.
Let’s take an example where you paid a vendor, but they altered the amount and cashed it afterward. When you compare your receipts to the amount taken out of your account, you might not become aware of it until you see it on your financial statements.
- Monitoring Cash Flow
Monitoring your company’s cash flow is crucial if you’re a business owner. You can plan your payments and make cost-effective purchases by using bank reconciliation, which shows you how money enters your accounting records and combines with your bank balance.
- Precise Tax Reporting
Both your personal balance and the balance on your bank statement need to be exact for your tax return to be accurate. Certain banks make it simple to calculate taxes, which results in more accurate tax reporting for the amount in your cash account.
Nevertheless, bank reconciliations can further facilitate this work. Bank reconciliation can lower the possibility of any error if you use tax software. For the purpose of making sure your tax return is accurate, you should think about checking your bank statement at least once every few months.
When must you Reconcile Your Bank Statements?
The frequency of bank reconciliation depends on your business activity. Here is how frequently you must have your cash balance checked together with your bank account.
- Daily
Fraud is more likely to occur in a business with a big volume. It is for this reason that you ought to think about daily cash book balance reconciliation. This will allow you to verify that there are no inconsistencies in the account and that the money is coming in and going out at a sufficient rate.
- Monthly
A bank reconciliation must be performed by every company at least once a month. This is true if you receive an average flow of the same volume each day. For businesses with seasonal flow, quarterly cash balance reconciliations might be enough to avoid problems.
- Quarterly or Yearly
A low volume of activity in the company means that the monthly cash balance reconciliation is not required. Having said that, the bank account should be closed and transferred to a more active one if it receives little activity. This may facilitate the process of reconciliation.
What are the Disadvantages of not Reconciling Bank Statements?
When your cash balance varies and the sums on your accounts differ, you need to find a way to explain them somehow. You can find the problems and fix them before they become serious ones by reconciling your bank account.
Companies that don’t regularly reconcile their bank accounts run the danger of falling prey to fraud, mistakes made by the bank, or unapproved withdrawals. If left ignored, this could result in cash flow leaks that could eventually harm the expansion and general functioning of your company.
Furthermore, a small business runs the risk of having its checks bounce and its digital payments rejected if it doesn’t perform regular bank reconciliation. Strict payment terms and higher costs may follow, harming the relationships with the partners and suppliers.
The legal protection afforded to personal accounts is not extended to company accounts. This implies that whereas a minor error, like a bank blunder, can be readily fixed, fraudulent behavior is a different story.
It is the responsibility of the companies to put an end to this form of fraud. Bank reconciliation assists in identifying these issues so they don’t persist for an extended period of time.
How to Reconcile Your Bank Statements
Your preferred banking institution will probably send you a bank statement on a regular basis. Monthly bank statements are permitted by certain banks, however quarterly delivery is also an option.
Here are the steps you need to take when it is time for bank reconciliation:
Fix Potential Issues
Often, your bank statements may have possible problems. The bank reconciliation procedure may assist you in identifying them so that there are no differences in your bank account. This may comprise the following problems:
- A voided check that cleared your bank statement
- Any transaction that has been recorded twice by your bank
- Issues in the bank statement
- Old outstanding checks should be avoided
By comparing the information on your accounting system with your bank balance, bank reconciliation can highlight these issues and help you address them.
Check Identity Dissimilarities
It’s usual to witness timing dissimilarities every now and again, like an outstanding check or any deposit that is still in transit. Maybe your business got a payment that has been in your business deposit, however, the bank was not aware of it.
For this reason, it’s crucial to check the amount of your personal cash account and your bank statement. You might be able to recover any possible costs that your bank might have taken out of the deposit in this way.
Change the Balances
You must update the balances on your bank account now that you are aware of the issue. Add the pending checks that showed up on your bank reconciliation statement, correct any inaccuracies, and deduct the deposits that were in transit.
You have to deduct the interest income that your bank recorded from the journal entries and add any possible fines and bank fees. It is imperative to rectify the error, regardless of whether it originated from the bank’s or your accounting procedure.
Compare Your Balances
Gather all of your accounting documentation for the time periods shown on your bank statement. Anything from receipts to account withdrawals you made during that period can be included in this.
Examine all of your withdrawals and deposits to see if they line up with the costs and cashing of your account. Remember to include withdrawal costs as well as any other possible bank fees related to your preferred financial institution.
Compare Changed Balances Again
It’s time to compare your cash balances as well, now that you have your adjusted bank balance. Everything needs to be in line with your bank reconciliation procedure at this point. If it doesn’t, you’ll need to go back and repeat the earlier procedures in search of an inconsistency.
Modify Journal Entries
Now when your bank reconciliation statement displays that everything is relevant, you need to make the final changes to your journal entries. You may add the following:
- Interest income that your bank may have registered
- Bank fees or penalties that your bank may have registered
In case the discrepancies are present in your books, then this is your signal that you must fix any data entry errors.
What are the Usual Issues in Reconciling Bank Statements?
For small business owners, bank reconciliations are essential, and it’s important to regularly check that your financial statement and book balance match.
Nevertheless, there are still certain difficulties you can encounter occasionally, particularly if you are manually reconciling your bank statement.
These are a few of the most typical ones:
Potential Human Error
Human error is also more likely when performing the bank reconciliation by hand. This might not work out well for you if your goal is an accurate finishing balance. More mistakes can be made than you are attempting to correct.
It is possible to accelerate the procedure by using an automated cash account. By doing this, you may increase the accuracy of your bank reconciliation and lower the possibility of human error.
Slow Data Input
An analyst must manually enter into the bank account, retrieve the bank statement, and confirm that the sums exactly match the information in your ERP system before finalizing the bank reconciliation. The cash transactions and any other data input mistakes that came from your cash account must be examined.
The manual involvement involved in creating this reconciliation statement may cause the data input process to be slow. If you use a financial platform with an automation system, this might not be the case.
Lack of a Central Audit System
Once the bank reconciliation statement is ready, it needs to be preserved for auditing needs. It can be quite simple to perform online using systems. But keeping up that paper trail for the two cash amounts might be challenging if it’s done by hand.
Comparing your internal financial records with the records your bank has given you is the simplest way to reconcile your bank statements.
This procedure is crucial because it guarantees that any anomalous transactions resulting from fraud or accounting mistakes will be easily recognized. The practice can assist you as a firm in identifying inefficiencies and managing cash flow.
