Bank reconciliation may sound like a tedious task, and it could very well be. However, as a business owner, it's one of those tasks you need to do to ensure a properly managed cash flow. To do bank reconciliation, take your bank statement for a given period and compare it with your financial records to check and ensure the balance matches.
Performing a bank reconciliation not only helps you see how your business is doing but also allows you to catch any transaction mistakes or fraud. This guide will discuss what bank statement reconciliation is, how to do it, and how often to do it, and will offer some tips on how to make the task easier.
What Is a Bank Reconciliation?
Bank reconciliation is vital to your business's overall financial health because it compares your bank cash deposits and withdrawals with your bookkeeping records. This allows you to check for any inconsistencies or discrepancies, which you can then investigate, resolve, or adjust your records accordingly. That's why it's important to do bank reconciliation regularly, which could be daily, weekly, or monthly depending on how many transactions your business does.
Before we get too deep into this discussion, note that you only need to do a bank reconciliation if you subscribe to the accrual method of accounting for your business. Accrual accounting is the practice of recording revenue when it's earned and not when payment is received. Expenses are also recorded when they're incurred, regardless of when they're paid.
For instance, suppose you have a custom T-shirt printing business and you received and fulfilled an order in late December. Since you give your customer a seven-day grace period to pay, the payment didn't clear until January. Under the accrual method, the income and expenses associated with that order are still recorded in December on your books.
On the other hand, the cash accounting method records income when payment is received regardless of when you delivered the goods or rendered the services. Your book balance and bank statements should match, and you don't need to reconcile them.
If you're wondering why businesses use accrual accounting when there's an easier method, it's because the accrual method of accounting records a business's assets, liabilities, and income in a specific period accurately. Through this method, a business owner can see how the company is performing month after month or even week after week.
Why Is Bank Reconciliation Important?
A properly managed cash flow ensures you have enough working capital to keep your business running. Hence, the information recorded on your ledger must match the money you have in your bank account. Performing bank reconciliation reveals how your business is earning and spending money.
Other benefits of the bank reconciliation process include:
- It allows you to check for errors made in recording, like calculation mistakes, payments you might have issued twice, or amounts you thought you received but weren't deposited by a client.
- You can keep track of your accounts payable. Are you paying your bills on time or are you incurring penalties and fines for late payments?
- You can keep track of your accounts receivable. Are you receiving payments from clients on time?
- You can record and adjust your books for bank fees or bank errors.
- You can spot fraudulent transactions and theft. It could happen; it's best to have an internal control procedure to detect these issues.
How Do You Do Bank Reconciliation?
The purpose of reconciling your books and your bank statement is to make sure they match and adjust each record accordingly to account for any inconsistencies. Before you start your bank reconciliation, it's important to ensure that your books are up to date. Once that's done, you are set to go.
Follow along below for a step-by-step process of reconciling your books.
Compare Your Cash Account and Bank Statement
The first step is to take your general ledger cash account and your bank statement and check the ending balances for a specific period, such as Dec. 31. Don't worry if they don't match. They rarely do, even if you record and reconcile meticulously.
Now that you have the ending balance for each account, find out why they don't match through the following steps:
- Match the deposits in your general ledger account with the bank transactions.
- Compare each amount entered in your books with those in the bank statement.
- Check for transactions recorded in your books but don't appear in the bank's records, like deposits in transit, checks you've issued to vendors that haven't cleared yet, or checks from clients returned for nonsufficient funds (NSF).
- Check for transactions shown in your bank statement not recorded in your books, like bank fees or penalties and deposits made directly to your account by clients.
Adjust the Bank Statement Balance
Here's how to adjust your bank statement balance:
|Ending Balance on Bank Statement
|Add Back: Deposits in Transit
|Deduct: Outstanding Checks
|Adjusted Bank Statement Balance
You'll need to understand:
- Deposits in transit: These are amounts you've deposited and recorded on your ledger but haven't been processed by the bank yet.
- Outstanding checks: These are checks you've issued for withdrawal but haven't cleared yet.
Adjust Your Business Account Cash Balance
Here's how to adjust the balance of your cash account:
|Ending Balance on Cash Account
|Add: Interest Earned
|Deduct: Service Charges /Penalties
|Adjusted Bank Statement Balance
You should also check for errors, such as a transposition error, which involves switching digits within an amount. An example would be if a check for $358 was recorded as $385. When this happens, add or subtract the difference to the cash account.
Record the Adjusted Balances
When the bank processes the deposits in transit to your account or cleared checks you've issued for withdrawal, the account balance on your bank statement should adjust naturally. You don't have to record the changes.
To record the adjustment to your cash account, you have two options:
Adjusting journal entries: You'll record the adjustments in the general ledger, which could be an Excel sheet or through accounting software like that offered by Skynova. Remember to add an explanation for the entry.
Below is an example of a journal entry to record adjustments for the following: a customer's check for $1,000 that was returned for NSF, bank charges of $80 withdrawn directly from the account, and an interest income of $200.
Debit Credit Accounts Receivable 1,000.00 Cash 200.00 Bank Charges 80.00 Cash 1,080.00 Interest Income 200.00 To record adjustments from bank reconciliation.
A bank reconciliation statement: See the example below.
Example of a Bank Reconciliation Statement
Take a look at this company's end-of-the-month reconciliation statement with the following adjustments:
- Bank statement ending balance is $25,000
- General ledger account has an ending balance of $22,000
- Bank statement shows a $60 bank charge
- Bank statement recorded interest income of $60
- A check for $3,500 issued for withdrawal hasn't been cleared by the bank
- A deposit of $4,000 is not on the bank statement
- A check for the amount of $260 issued to a vendor was recorded as $160
- A notes receivable of $4,280 from a customer was deposited to the account
- A check of $680 deposited by the company has been charged back as NSF
Bank Reconciliation Statement
Dec. 31, 2020
|Ending Bank Balance, Dec. 31, 2020
|Add: Deposits in Transit
|Deduct: Outstanding Checks
|Adjusted Cash Balance
|Balance on Cash Account, Dec. 31, 2020
|Add: Receivable Deposited to Account
|Deduct: NSF Check
|Error in Check
|Adjusted Cash Balance
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