Bank Reconciliation: What is it? Why do you need to do it? More importantly, how do you do it?
As a small business, you’re writing checks, making deposits and receiving and making payments. You’re recording these transactions in your books which can become a nightmare at the best of times.
To make matters more complicated, you now receive your monthly bank statement and discover it doesn’t match your cash balances. The bank has debited your account for items you have no knowledge of. There are even transactions you’ve recorded in one month that reflect in another. And so it goes on…
These situations highlight the need for bank reconciliation or, as you may know it, “bank rec.” But what exactly is bank reconciliation? How often should I do it? Do I need it? And, once I’ve decided I need it, how do I do it?
In this post, we explore bank reconciliation in detail and show you how easy it is to do it.
Let’s jump in.
What Is Bank Reconciliation?
Many of you will record cash transactions in a cash book. Your cash book will contain a record of your cash account (receipts and payments of money).
Once you’ve balanced the cash account for the month, it’s common to compare these balances against your bank statements to see if they match. If they don’t, you need to make adjustments and create a bank reconciliation statement.
You may know this process as bank reconciliation, reconciling the bank statement, bank statement reconciliation or even “bank rec.” But, how exactly do these discrepancies arise that require you to do bank reconciliations?
They usually occur because of bank errors, your mistakes or timing differences.
Indeed timing differences are often one of the biggest reasons for discrepancies. The following examples may sound familiar:
- You write a check at the end of the month and record it immediately. Your bank, however, may (and often does) only records it the next month.
- A client makes a payment into your account at the end of the month. The bank immediately records it. You, only become aware of it the next month.
- The bank debits your account for bank charges or even interest on your overdraft in one month. You only see those deductions when you receive your bank statements.
The sheer number of transactions can compound these problems. After all, you write many checks, make many deposits and receive and make plenty of payments. Tracking all this can be difficult and not to mention time-consuming.
This is why you need to complete bank reconciliation monthly, to minimize the work involved. You don’t want to be backtracking months and months into the past to see where the error is.
But, Why Do You Need to Do Bank Reconciliation?
Bank reconciliation offers several benefits:
- It provides accuracy and consistency in your accounting records
- The accuracy of records prevents you from transferring errors over to your financial statements
- It protects you against fraud and lost revenue
- It provides an accurate account of your current cash flow status so that you know exactly where your business stands. You’ll be able to pinpoint any cash flow problems better and take action to improve your cash flow.
- Many audit firms request these when they’re doing an annual audit. Do “bank rec” often, and you’ll have the information ready to go.
With an overview provided and the benefits clear, how exactly do you do it?
Let’s have a look.
The Bank Reconciliation Process
Let’s assume you’ve balanced your cash book for August and the balance is $1300 as of the 31 August 2020.
A week later you receive the bank statement with a balance of $1500. There’s a discrepancy of $200 that you need to reconcile.
We’ll show you how to reconcile these balances in four steps with examples.
Step 1: See Which Items Appear in the Cash Account and Bank Statement
Mark the items that appear in both the bank statement and cash book.
Now turn your attention to the unmarked items in your cash book and bank statement. Here are some examples we’ll reconcile.
Unmarked items in the cash book:
- $30 payment made to a supplier via cheque
- $20 payment made to a supplier via cheque
Unmarked items in the bank statement:
- Receipt of $150 (a payment made from a client)
Step 2: Update the Cash Book with the Unmarked Items from the Bank Statement
You’ll now need to update your cash book with the $150 and increase receipts by $150. Why? Because you’ve received this money as reflected in your bank statement, but you have yet to record it in your cash book.
Step 3: Work out Your Updated Cash Book Balance
Your new cash book balance will be $1,450 ($1,300+$150). You’ll use this new cash book balance and the unmarked items in your cash book to create the bank reconciliation statement.
Step 4: Prepare the Bank Reconciliation Statement
Here’s what you’ll do in the bank reconciliation statement:
- Enter the revised cash book balance of $1,450
- Add the cheques of $50 to the balance
You add the cheques because your bank has yet to record and deduct these amounts from the bank statement (hence the higher value in your bank statement). The bank will only record these transactions the next month.
The balance in the Bank Reconciliation statement is now $1,500—the same as the bank statement. And that’s how you do a bank reconciliation. It’s that simple.
In this example, you didn’t have to include deductions to your bank reconciliation statement. You would make deductions, for instance, if you received money at the end of the month. Why? Because you can record it in your cash book for that month, but your bank can’t due to the lateness of the transaction.
If you’re looking for more examples of how to do a bank reconciliation, read Bank Reconciliation Statement by Osborne Books.
Tip: Invest in online tools like FreshBooks to take the manual grunt work out of it.
Bank reconciliation is a process of comparing your cash book balance against your bank statements. From there you make the necessary adjustments.
It’s an essential process for any business and has many benefits. Bank reconciliation:
- Ensures your accounting records are accurate
- Helps you catch any errors before compiling other financial statements
- Protects you against fraud
- Gives you an overview of your current cash flow status and helps you pinpoint problems
While the benefits are clear, many see it as a daunting task. It is, however, anything but daunting. In fact, you can do it in four simple steps and if you want to make it even easier, use the many online tools.
What’s your experience with bank reconciliation?