What is bank reconciliation? You might have come across this term many times without truly knowing what it meant. As a business owner, it’s important to know the ins and outs of the business, especially in the financial field. That’s why in this article, we’re going to discuss what is a bank reconciliation and how do you do it?
What is a Bank Reconciliation?
A bank reconciliation is a piece of document that shows a direct comparison between a company’s cash balance sheet and the corresponding amount that reflects on its bank statement. The information you get in this document will let you reconcile your accounts and make sure they are accurate and balanced. By reconciling both accounts, you can identify any issues that would prompt you to change your accounting.
Bank reconciliations are done regularly to ensure that your company’s cash records are accurate and correct. At the same time, it also helps detect potential threats like cash manipulation and other fraudulent activity.
Purpose of Bank Reconciliation
The process of bank reconciliation is essential to keep your finances in check and determine whether there are issues you need to deal with. Reconciling your bank statement offers several advantages, namely the following:
- Helps detect issues such as missed payments, double payments, calculations errors, and more.
- Tracks and adds bank fees and penalties to your company’s books.
- Spots potential theft and other fraudulent transactions.
- Keeps track of the business’s accounts payable and receivables.
Bank reconciliation done manually can be hard work. By relying on accounting software, it can be made easier and error-free. With accounting tools like FreshBooks, all your company’s transactions are imported automatically. This level of convenience will allow you to match and categorize a large number of transactions at a mere click of a button. Not only is it convenient but it will also make the entire bank reconciliation process controllable and more efficient.
Reasons for Difference Between a Company’s Bank Statement and Accounting Records
When the bank sends a bank statement, it usually contains the following details: the company’s beginning cash balance, transactions during that particular period, and the ending cash balance. However, in most cases, both the bank and the company’s ending cash balance are not the same. Here are some of the reasons for the difference:
- Deposits in transit: cash and checks that were received and recorded by the company yet were not recorded on the bank statement since it’s still “in transit.”
- Outstanding checks: checks that are issued by the company to the creditors, but the payments are yet to be processed.
- Bank service fees: banks deduct charges for the services they provide to their customers, but the payments are usually relatively small that they don’t include them in their bank statement.
- Interest income: banks pay interest on certain bank accounts.
- Non-sufficient funds (NSF) checks: when a customer or client deposits a check into an account but the account of the check issuer has an insufficient amount to pay said check, the bank will deduct the check that was previously credited from the customer’s account. As a result, the check is then returned to the depositor as an NSF check.
In today’s accounting trends that feature steep demands, many companies use specialized accounting software for bank reconciliation to reduce the amount of work needed. At the same time, it also reduces the adjustments required, as well as enables real-time updates.
How to Reconcile Bank Statements?
To reconcile your bank statement, the account balance as reported by the company’s bank is compared to the general ledger of a business. Businesses will then maintain a cash book that shoes the cash available while the bank column reflects the cash at the bank.
The bank also needs to keep tabs on every customer. In the bank books, the deposits are recorded on ‘credit’ while withdrawals are recorded on ‘debit.’ The bank will then send the account statement to its customers every month or at regular intervals.
Sometimes, these balances don’t match. That’s why the business needs to identify the reason for the discrepancy and reconcile the differences. This is done to confirm that every item is accounted for and the ending balances will match accurately.
To achieve a balance between your company and your bank’s account statement, you will need to do bank reconciliation by preparing a reconciliation statement.
Step-by-Step Guide to Bank Reconciliation
Typically, before you reconcile your bank, you mostly receive your bank statement at the end of each month, courtesy of the bank. The statement features an itemized list of the cash and deposits made into the checking account of the business. That statement also includes bank charges like servicing fees. Once you’ve received it, follow the steps outline below to reconcile your bank statement (also mentioned in AccountingTools.com):
Step #1: Compare the Deposits
Check and match the deposits in the business records with those in the bank statement. Make comparisons of the following:
- The deposits are recorded in the cashbook’s debit section of the bank column with the credit side of the bank statement.
- The credit section of the bank column with the debit section of the bank statement.
- Mark the same items that appear in both the records.
Step #2: Make adjustments to the Bank Statement
Once you have the details about your bank statement and company statement, start adjusting the balance on the bank statements to the correct and accurate balance. To do this, you must do the following:
- Add all of the deposits in transit during that particular period,
- Deduct outstanding checks; and
- Add or deduct bank errors.
Deposits in Transit
As mentioned earlier, deposits in transit are money received and recorded by the business but are not yet recorded by the bank. To make the balance, you will need to add deposits in transit to your bank statement.
Outstanding Checks
Outstanding checks are statements that have been written and recorded in the cash account of the business. However, the bank account hasn’t been cleared. Outstanding statements need to be deducted from the bank’s balance. This process usually happens when the checks are written in the last few days of the month.
Bank Errors
Bank errors are mistakes and miscalculations made by the bank while creating the company’s bank statement. Some common bank errors include the following:
- Entering an incorrect bank account
- Omitting an amount from the bank statement
- Inputting the wrong numbers
Make sure you compare the cash account’s general ledger to the bank statement to spot potential errors.
Step #3: Make Adjustments to the Cash Account
The next step you need to do is adjusting the cash balance in the business account. You can do so by adding the interest or deducting the overdraft fees and monthly charges. Before you can do this, you need to take into account the bank charges, NSF checks, and accounting errors.
Fees will be deducted from your bank statement to cover the bank’s processing services. These fees can include charges from overdrawing your account or monthly charges. If your bank account earns interest from its current balance, it must also be added to the cash account.
As mentioned earlier, a non-sufficient funds (NSF) check is a type of check that has yet to be honored by the bank due to insufficient funds in the entity’s bank accounts. The check amount hasn’t been deposited into your bank account; therefore, it needs to be deducted from your cash account records to balance your statements.
Any potential error in the cash account can result in an inaccurate amount being entered or an amount being omitted from the records. The correction of the error will then increase or decrease the cash account in your company’s books.
Step #4: Compare Both Balances
After adjusting the balances according to both the bank and the books, the adjusted amounts should then be similar. However; if for some reason, they’re still not equal, you will have to repeat the entire bank reconciliation process until both are accurate.
Once the balances are equal, you will then need to prepare journal entries for the adjustments to the balance per book.
How Often Should You Reconcile Your Bank Account?
To make sure your bank reconciliation efforts are worth it, you’ll need to find out how often you need to do the process. Ideally, you’d want to reconcile your bank account every time you receive a statement from your bank. Your bank usually sends your bank statement at the end of every month, week, and even at the end of each day. This frequency will depend on the type of business that you run and the number of transactions that you do.
Before you start the reconciliation process, you need to make sure that they have a record of all your transactions from the beginning up to the end of your bank statement. Businesses that are using online banking services can download the bank statements for the regular reconciliation process instead of having to enter the information manually.
Wrapping Up
By understanding what bank reconciliation is, you’ll be more mindful of its importance the next time you reconcile your bank statement. Make sure you follow each step in this quick guide to help you manage your bank reconciliation duties without running into problems and errors on your document.
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