Why Conduct a Bank Reconciliation
Why conduct a bank reconciliation? Because cash flow is important to a business, the cash balance shown on a company’s balance sheet and bank statement must be accurate to help manage, run and grow the business. Since the balances between these two records may not agree, a bank reconciliation is performed monthly to identify and explain differences that may result from the timing of posted activities, errors made by the bank or the company, fraudulent activities of a company’s employees or simply prevent problems.
Bank reconciliation is the practice of comparing your records against the bank records. A monthly reconciliation helps you identify any unusual transactions that might be caused by fraud or accounting errors. This is the most common reconciliation done with companies monthly. The common errors a bank reconciliation can catch are typically related to these five key areas.
Essentially reconciling your account also helps you identify issues that might need attention. For example, you might need to reevaluate how you handle cash flow and accounts receivable, or you might need to change your recordkeeping system and the accounting processes you use.
1. Know how much you really have available in your accounts
2. Avoid bouncing checks (or making failed electronic payments) to partners and suppliers
3. Avoid bank fees for insufficient funds or going into lines of credit when you don’t really need to
4. Know if customer payments have bounced or failed and if any action is needed
5. Keep track of your outstanding checks
6. Make sure everything is going into your accounting system properly
7. Catch bank errors
Bank reconciliations help to identify errors that can result from checks that are incorrectly posted to a company’s bank account. For example, if a company deposits a check in the amount of $6,300, yet the bank mistakenly credits the bank account for $8,300, a reconciliation of the deposits shown on the company’s bank statement with the balance shown on its books may identify the error.
A monthly bank reconciliation can help detect fraudulent activities perpetrated by a company’s employees. If an employee tampers with a check to change the endorsement amount, the fraud can be detected through a bank reconciliation that compares the disbursed check amounts on the company’s books with the check details shown on its monthly bank statement. With a cash transaction, the cashier is committing fraud by not recording cash received from customers. By doing this, the customer and cash ledgers are unchanged and they can pocket the cash received. A simple way to detect frauds like this is to perform a reconciliation. When the actual sales are compared to the cash received the balances will not match and the fraud will be detected.
A bank reconciliation also identifies discrepancies between a company’s cash balance on its bank statement and its books that may not be the result of an error or fraud but the result of a timing difference. This is the case with “deposits in transit” — customer checks that have not posted to the company’s bank account but have been posted to its books. For example, if a company receives and enters on its records a client check in the amount of $1,700 on Oct. 30, also the date of its bank statement, the difference between the company’s books and its bank balance is the result of a timing difference, not an error.
Maintain Accurate Records
A company’s cash balance is presented on its balance sheet within the current assets section and is the company’s most liquid asset. Since a company’s cash balance is included in many key profitability and liquidity ratios that evaluate a company’s performance and financial situation, the balance should be reconciled monthly to ensure that it is both accurate and reliable.
Over the years I’ve seen companies ignore this important function and essentially all I can say to them when they ask “why conduct a bank reconciliation?” My response is “you don’t know what you are missing”, no pun intended.