What is a bank reconciliation, and why is it important?

The general ledger includes a record of a company’s cash transactions, and a bank statement tracks all money flowing in and out of a company’s account. So, theoretically, these two statements should carry the same information and result in the same cash balances. However, in practice, this is rarely the case. To balance these two documents, businesses of all sizes need to perform regular reviews, called bank reconciliations.

What is a Bank Reconciliation?

A bank reconciliation is matching information regarding cash accounts from accounting records to the corresponding information on bank statements. Simply put, a reconciliation is how a business makes sure it has the cash it thinks it has.

While financial statements like the general ledger indicate how much money a business should have. A bank statement means how much money a company has because it is an accurate picture of all the completed transactions over a specific time that affected its account.

With payments and deposits constantly in transit and additional items like interest and bank fees to account for, it is improbable that the two will balance on their own. The goal is to find the difference between the two and book accounting entries, where needed, to make them match.

Bank Reconciliation Statement

The term “bank reconciliation” actually refers to the process of verifying and adjusting cash movement. In contrast, a bank reconciliation statement is a formal document that a business prepares to maintain its records.

Partners or financiers may require bank reconciliation statements as part of the funding process, and they are helpful in the case of an audit. After performing a bank reconciliation, it is advised that the document is kept on file like any other financial statement that a business generates and held onto as part of its records.

Typically, bookkeepers or accountants will prepare the bank reconciliation statement either by hand or with the help of integrated accounting software. However, some businesses employ third-party providers to reconcile their bank records for improved accuracy and turnaround time. This is especially common with larger companies that have more transactions to account for each month.

Problems That Arise with Bank Reconciliations

Two central problems can arise with a manual, spreadsheet-driven bank reconciliation process. The first one is that mistakes become commonplace. There is vital room for human error when your accountants are working by multi-tab Excel workbooks that include hundreds or thousands of line items that need to be overviewed. And though the very purpose of the reconciliation is to validate bank account balance accuracy, fat-fingering or transposing a number, among other things, is common in spreadsheets.

The second main issue that can arise with a manual bank reconciliation process is that fraud may not be detected promptly, or in some cases, goes undetected.

Bank reconciliations are performed at the end of the month after the transactions have already been recorded. If an employee tries to commit fraud at the beginning of the month, accountants reconciling the bank statement transactions won’t catch the discrepancy until a month later, sometimes longer.

When fraudulent-like activities occur, they should be discovered and resolved as soon as possible, or the magnitude of the problem

Why is a Bank Reconciliation Important?

Bank reconciliations need to be done regularly to identify discrepancies before they become problems. In the absence of regular bank reconciliations, businesses can end up with bounced checks and failed electronic payments in the short term and even become financially overstretched in a long time. All these outcomes affect cash flow, which can hurt the sustainability and future growth of the business.

Periodic bank reconciliations also help to catch fraud and cash manipulations quickly to minimize damage to the company. Business accounts do not have the same federal protections that consumer accounts do, so the bank does not have to cover fraud or errors in the report. Therefore, performing a bank reconciliation is an essential step in safeguarding the company from losing money unnecessarily.

Benefits of Performing a Bank Reconciliation

After performing a bank reconciliation, a business will have:

  • Greater confidence in the amount of cash that it has on hand
  • A reduction in bounced checks to suppliers and partners, which improves brand trust and can earn more flexible payment terms
  • Insight into which customer or supplier payments have failed to enable better decision-making around attempting to collect payment
  • Cleaner books and more significant business confidence to attract investors

Follow our bank reconciliation series for more insight into this vital topic. We will be featuring advice on how often to perform a bank reconciliation, what is needed, fixing common problems that can arise, and a step-by-step tutorial on doing a bank reconciliation for the first time.