What Is Bank Reconciliation? A Brief Guide for Business Owners

First thing’s first: What is Bank Reconciliation?

Bank reconciliation is the process of aligning internal documentation with the balances shown on your bank statements. Quality record-keeping and attention to detail are the most important aspects of this task.

For growing businesses, bank reconciliation can seem complicated, but it has important benefits that could optimize cash-flow management and even prevent fraud. 

Why Is It Important to Reconcile Your Bank Statements?

Entrepreneurship comes with many responsibilities, so it can be hard to justify the time spent reconciling a bank statement, especially if you have a small team. 

Nevertheless, there are quite a few reasons you should:

• Monitoring Cash Flow: Reconciling bank statements requires you to examine your finances in detail, often leading to valuable insights about your business.
  
• Maintaining Tax Accuracy: Audit rates are low for all but the largest businesses and highest earners (between 1-10%), but protecting yourself isn’t the only reason to maintain accuracy. Maximizing tax deductions also relies on accurate records; reconciliation can save money on your tax bill.
  
• Catching Unintentional Errors: Sometimes, a payment from a customer doesn’t go through, or the bank will make a mistake. Re-examining transactions regularly helps you catch these discrepancies.
  
• Detecting Fraud: Businesses that fail to monitor their finances closely are most at risk for fraud. Bank reconciliation reduces this risk. 

How to Reconcile a Bank Statement

While the process is simple enough to understand, the detail-oriented nature of the work can be complex. That’s why entrepreneurs hire online bookkeepers for help. 

In short, bank reconciliation follows these steps:

1. Gather bank and internal records.
   
2. Compare documents side by side.
   
3. Investigate discrepancies.
   
4. Note internal errors in your general ledger.
   
5. Contact your bank if there is an error on their end. 

How to Prepare a Bank Reconciliation

Internal record keeping is the hardest part of bank reconciliation, and the best way to prepare is to be organized in advance. 

Here are some best practices to put in place to simplify the bank reconciliation process: 

• Use separate accounts for business and personal finances to avoid confusion.
  
• Implement a systematized method for tracking business expenses.
  
• Train staff on proper record-keeping to ensure consistency and accuracy.
  
• Use accounting software, rather than spreadsheets, to track and automate processes.
  
• Retain documentation, including receipts and invoices.

Errors to Look For

Figuring out why discrepancies exist in your records can be the most challenging part of bank reconciliation. 

Here are some of the most common reasons behind mismatches, according to indinero’s bank reconciliation services team: 

• Bank Fees and Interest on Deposits: Since these are automatically added to or drawn from your account, it can be easy to miss them on your internal records. 

• Deposits in Transit: When reconciling at the end of the month, you’ll often encounter pending invoices or payments that still need a few business days to clear.
  
• Non-Sufficient Funds (NSF): Sometimes, a customer pays an invoice, and the transaction bounces. Since most businesses create records at the time of the transaction, your internal ledger might reflect more money than is in your account.
  
• Recording Errors and Omissions: The bank will help catch these. Some mistakes are as simple as a typo or a missing record. 

How Often Should Companies Reconcile Their Bank Statements?

To catch mistakes quickly, it’s best to reconcile at the end of every month.  

Some companies may choose to do so more frequently, depending on the complexity of their transactions and the level of risk they are willing to tolerate, but monthly reconciliation is the most common practice. 

Waiting longer than a month to perform bank reconciliation could leave you with more data than is manageable or cause you to miss your chance to correct errors or report fraud quickly. 

Bank Reconciliation Example

Below are the internal cash account and bank statements for Acme Inc., a company we made up for this example.

You’ll notice that the ending balances don’t match; that’s because we’ve included some of the most common errors you might encounter, along with an explanation for each. 

Before looking at our explanations, see if you can spot the errors yourself.

Acme Inc. (May 31, Internal Cash Account)

Acme Inc. (May 31 Bank Statement)

In order of appearance, here are explanations for the errors:

• The May 7 deposit records don’t match. Acme’s internal bookkeepers have made a typo and replaced $569 with $596.
  
• The May 31 deposit appears on Acme’s internal records but not the bank statement. Since it was made at the end of the month, it’s a “deposit in transit.” The bank will need a few business days to process it.
  
• The bank has a May 18 debit that isn’t on Acme’s internal records. Our bookkeepers forgot to make the appropriate entry.
  
• At the end of the month, the bank charged a maintenance fee and credited Acme with interest on our deposits. End-of-month reconciliation is the perfect time to update these internal records. 

Now that we’ve identified the sources of error, the last thing we’ll need to do is update our internal records to reflect them. Regarding the deposit in transit, we’ll verify that the bank received the deposit when we reconcile next month.

What Does Fraud Look Like?

Hopefully, you never encounter this in your business. But just in case, here are some signs of fraud you may detect during a bank reconciliation: 

• Unexplained Transactions: Look for exchanges that don’t appear on your bank statement or vice versa, especially large ones.
  
• Duplicate Transactions: Duplicate transactions might indicate someone trying to manipulate records. For instance, recording an expense twice could allow for a matching withdrawal from the company bank account without creating a mismatch between internal and external records.
  
• Unusual Patterns: Transactions occurring at odd times or unusual locations could indicate foul play.
  
• Missing Documentation: Fraudulent activity often lacks supporting documents, such as invoices or receipts. 

If you think you’ve detected fraudulent activity, inform the appropriate authority within your company and contact your bank regarding any suspicious transactions.

Preventing Fraud

Implementing a handful of preventative measures is the best way to avoid encountering fraud. Here are the most vital:

• Segregation of Duties: No individual should have complete control over financial processes.
  
• Dual Authorization: Significant purchases require multiple people’s approval before the transaction can go through. 

• Monthly Bank Reconciliation: It may not be possible to catch the first instance of fraud, but regularly examining discrepancies can stop ongoing wrongdoing.
  
• Secure Access Controls: Strong passwords and multi-factor authentication can prevent unauthorized access.

Conclusion 

Proactive record-keeping systems and monthly account reconciliations can ensure tax compliance, maximize deductions, help detect errors, and prevent fraud. 

If you’d like help navigating this detail-oriented task, contact indinero’s bank reconciliation services team today.