Why reconcile bank statements? Importance and benefits explained

Why is it important to reconcile your bank account?

Reconciliation is a crucial accounting process that ensures the accuracy of the financial closing process. It ensures that the money credited or debited to your bank account matches the money you spend or earn.

Reconciling the bank statement involves comparing the company's internal financial records or general ledger with the bank statement received through the bank. Bank reconciliation is essential as it helps early detection of fraud, prevents errors in financial statements during manual data entry, and provides a clearer picture of the company's finances.

Key findings:

• Bank reconciliation is the comparison of transactions in your records with the bank statement.
• Bank reconciliation is performed to detect differences between the two records, verify transaction amounts, and make any necessary adjustments.
• In the event of discrepancies, the financial controller must be involved in a further investigation.
• Bank reconciliation can help ensure that the company's financial reports are accurate when performed regularly.

Definition of bank reconciliation

Bank reconciliation is the process of matching each balance in the accounting records with the balance noted on the bank statement. In most cases, the balances reported in both records will differ slightly. There are several reasons why these differences occur (which we will discuss later), and bank reconciliation helps make the necessary adjustments so that accounts align and accurate financial reporting can be achieved.

The objective of bank reconciliation is:

1. Identify accounting errors such as duplicate payments, lost checks, and other errors made by humans during data entry.
2. Prevent fraud by flagging unrecorded transactions and investigating quickly.
3. Identify banking errors such as unauthorized fees and incorrect transactions posted.
4. Provide transparency in cash flows (inflows and outflows) to improve the overall efficiency of financial management. Knowing your true financial situation allows you to make informed decisions.

How often should you reconcile your bank statements?

Bank reconciliation should be performed regularly, and the frequency will depend on transaction volumes and business needs. Accounting teams typically need to reconcile their bank statements at least once a month since they address discrepancies, and errors can be problematic if adjustments are not properly made in a timely manner.

• Small businesses or individuals have transaction volumes at the lower end. They can benefit from reconciling their bank statements on a monthly basis.
• Big enterprises They have high transaction volumes and reconciling bank statements at the end of the month can lead to mishaps and human errors. These companies can perform weekly or daily reconciliations to monitor cash flows and address anomalies closely.

After bank statement reconciliation, it is prudent to periodically check the amounts being credited and debited from the account. This will help detect fraudulent activities and flag discrepancies, if any.

How to reconcile your bank statement?

Before explaining the process of how to perform a bank reconciliation, there are some essential terms that you should know

Outstanding checks:

These are payments that the company has sent and recorded but have not yet been settled by the bank. Similarly, checks received by the company but have not yet reached the account should be adjusted accordingly.

Cash transit:

Cash may not reflect immediately in the bank account when funds are transferred via credit card payments or bank transfers. Here we must also make the appropriate adjustments.

Bank interest and commissions for services.:

Banks deduct charges for services provided (usually relatively small), which must be adjusted accordingly for accurate reconciliation. Similarly, banks pay interest on bank accounts, which must be adjusted accordingly.

Bank reconciliation involves matching the money in the bank with the actual cash reflected in the cash book. Today, reconciliation is primarily automated using software to save time and money. However, let's understand the manual bank reconciliation process once:

Step 1: Gather documents

On the bank side, you need bank statements, outstanding checks, deposits, and any pending transactions. On the company's side, the company's cash book is needed, in which both incoming and outgoing transactions are recorded.

Step 2: Match deposits

After double entry accounting, a debit in the bank statement is recorded as a credit in the cash book and vice versa. Match the deposits on the two statements.

Note:In general, bank and cash balances are not expected to match due to outstanding transactions, such as outstanding checks or deposits in transit. They should be adjusted as shown in the following steps.

Step 3: Adjust the bank balance

The discrepancy between the two balances must be identified and verified on each individual transaction. Bank statements must be adjusted by adding outstanding deposits (deposit in transit) and deducting outstanding outgoing checks (outstanding checks). The logic here is:

Bank Balance + Deposits in Transit – Outstanding Checks = Adjusted Bank Balance

Step 4: Adjust cash books

The cash book balance needs adjustments to account for bank service fees, accrued interest, and bounced checks (NSF checks). The logic here is:

Cash Book Balance + Interest – Bank Fees – Returned Checks = Adjusted Cash Book

Step 5: Compare the balance

After adjustment, the bank balance and cash book should match. If they are not equal, there is an error in the reconciliation process. Any unjustified expenses or missing income should be investigated and accounted for during the reconciliation process.

Implications of not reconciling your bank statement

Several problems can arise if the differences between your records do not match.

Inaccurate financial reports:

The accounting team cannot accurately reflect the company's cash position without regular reconciliations. This can lead to poor financial decision making, incorrect financial statements, and errors during the tax filing process.

Poor cash flow management:

Unresolved discrepancies can cause problems in the company's cash flow. Without this information, accounting teams could ignore late payments, outstanding invoices, etc.

Increased risk of fraud:

Let's say you're trying to reconcile your bank statement by comparing the transactions on your credit card statement to your receipts. You might ignore these transactions if there are no paper receipts because the transaction amounts are low. However, if you're diligent, you can dispute the amounts with the credit card company and discover that the credit card information was revealed and a criminal is making the charges. In this case, you were able to detect fraud and cancel the credit card thanks to the reconciliation practice.

Costly mistakes:

Overstatements or understatements of income, expenses, or assets due to unreconciled accounts can result in inflated earnings, incorrect tax returns, and financial penalties.

In short, failing to periodically reconcile bank statements can lead to inaccurate financial records, cash flow problems, increased risk of fraud, reputational damage, and costly accounting errors. Performing timely reconciliations is an essential internal control for maintaining the integrity of your financial data.

Leverage nanonetworks for bank statement reconciliation

Staying on top of your regular bank statement reconciliation can be challenging but critical for accounting teams around the world. The bank statement reconciliation practice is very manual and does not scale well as transaction volume and reconciliation frequency increase.

To address this issue, Nanonets has developed an automated reconciliation software solution that helps in performing proper and accurate reconciliations and accommodates the increased volume of transactions.

To learn more about our solution, you can check out our product offering at Nanonets Automated Reconciliation or schedule a call with our reconciliation expert today.