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13 Min. Read

Bank Reconciliation: Definition, Example, and Process

How to Do Bank Reconciliation?

Accurate cash flow is essential for keeping a business running smoothly, so it’s important to be aware of all incoming and outgoing cash. A bank reconciliation is the process by which a company compares its internal financial statements to its bank statements to catch any discrepancies and gain a clear picture of its real cash flow.

We’ll explore the definition of bank reconciliation, why it’s important, and a step-by-step process for performing bank reconciliations. We’ll also look at common sources of discrepancies between financial statements and bank statements to help you identify fraud risks and errors. Performing regular bank reconciliations is key to keeping on top of your company’s financial health and paving the way for sustainable business growth.

Key Takeaways

  • A bank reconciliation balances a company’s financial statements and bank statements.
  • Regular bank reconciliations are important for monitoring cash flow and catching errors.
  • Bank reconciliations should be performed at least once a month.
  • Common discrepancies in bank reconciliations arise from payment delays and bank fees.
  • Accounting software can reduce the risk of errors on a company’s financial statement.

Table of Contents

What Is a Bank Reconciliation?

A bank reconciliation compares a company’s cash accounting statements against the cash it has in the bank. A bank reconciliation is used to detect any errors, catch discrepancies between the two, and provide an accurate picture of the company’s cash position that accounts for funds in transit.

Companies prepare bank reconciliation statements as a comprehensive accounting comparison tool. A company can ensure that all payments have been processed accurately by comparing their internal financial records against their bank account balance. Bank reconciliation statements are also important for alerting a company in case of fraud or error. To be effective, a bank reconciliation statement should include all transactions that impact a company’s financial accounts.

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Why Is It Important To Reconcile Your Bank Statements?

Reconciling your bank statements is important because it lets you catch any errors or discrepancies in your financial records. It can also serve as an early warning system for fraud.

Regularly reconciling your bank statements helps businesses detect potential issues with their financial recording system, making it easier to rectify those problems quickly. This can range from one-off errors such as calculation mistakes or double payments to major concerns like theft and fraud. 

By comparing your company’s internal accounting records to your bank statement balance, you can confirm that your records are accurate and analyze the reasons behind any potential discrepancies.

When To Do a Bank Reconciliation

It’s recommended for a company to perform a bank reconciliation at least once a month. If your company receives bank statements more frequently, for example, every week, you may also choose to do a bank reconciliation for every statement you receive.

The more frequently you do a bank reconciliation, the easier it is to catch any errors. Many companies may choose to do additional bank reconciliations in situations that involve large sums of money or that show unusual financial activity. This can include large payments and deposits or notifications of suspicious activity from your bank. In these situations, it’s a good idea to perform an immediate reconciliation.

How To Do a Bank Reconciliation 

You receive a bank statement, typically at the end of each month, from the bank. The statement itemizes the cash and other deposits made into the checking account of the business, as well as any expenses paid by the business. This includes everything from wages and salaries paid to employees to business purchases like equipment and materials. Bank statements also show expenses that may not have been included in financial statements, such as bank fees for account services. 

Once you’ve received it, follow these steps to reconcile a bank statement:

1. Compare the Deposits

Match the deposits in the business records with those in the bank statement. Compare the amount of each deposit recorded in the debit side of the bank column of the accounting records with the credit side of the bank statement and the credit side of the accounting records with the debit side of the bank statement. Mark the items appearing in both records.

2. Adjust the Bank Statements

Once you’ve identified all the items that align between the two records, it’s time to account for any discrepancies. These may include deposits in transit, outstanding checks, bank fees, or miscalculations by the bank or the internal accounting team.

Deposits in transit are amounts that are received and recorded by the business but are not yet recorded by the bank. They must be added to the bank statement.

Outstanding checks are those that have been written and recorded in the financial records of the business but have not yet cleared the bank account. They need to be deducted from the bank balance. This often happens when the checks are written in the last few days of the month.

Bank errors are mistakes made by the bank while creating the bank statement. Common errors include entering an incorrect amount or omitting an amount from the bank statement. These miscalculations can also occur on the business’s financial records.

Compare the business’s financial records to the bank statement to spot the errors. This can be accomplished by matching transactions, and then adding or deducting any transactions that do not align to balance the total amounts.

3. Compare the Balances

After adjusting the balances as per the bank and as per the books, the adjusted amounts should be the same. If they are still not equal, you will have to repeat the process of reconciliation.

Once the balances are equal, businesses need to prepare journal entries to adjust the balance per books.

4. Adjustments to the Cash Account

The next step is to adjust the cash balance in the business account.

Adjust the cash balances in the business account by adding interest or deducting monthly charges and overdraft fees. 

To do this, businesses need to take into account bank charges, NSF checks, and errors in accounting.

Bank charges are service charges and fees deducted for the bank’s processing of the business’s checking account activity. This can include monthly charges or charges from overdrawing your account. They must be deducted from your cash account. If you’ve earned any interest on your bank account balance, it must be added to the cash account.

An NSF (not sufficient funds) check is a check that has not been honored by the bank due to insufficient funds in the entity’s bank accounts. This means that the check amount has not been deposited in your bank account and hence needs to be deducted from your cash account records.

Errors in the cash account result in an incorrect amount being entered or an amount being omitted from the records. The correction of the error will increase or decrease the cash account in the books.

Bank Reconciliation Example

Let’s take a look at a hypothetical company’s bank and financial statements to see how to conduct a bank reconciliation.

Greg’s Lawnmowers is performing its monthly bank reconciliation. Greg’s January financial statement for the company shows $100,000 in cash, but the bank statement shows only $88,000. 

By comparing the two statements, Greg sees that there are $11,500 in checks for four orders of lawnmowers purchased near the end of the month. These checks are in transit, so they haven’t yet been deposited into the company’s bank account. He also finds $500 of bank service fees that hadn’t been included in his financial statement.

Greg adds the $11,500 of deposits in transit to his bank statement balance, bringing him to $99,500. He also subtracts the $500 in bank fees from his financial statement balance, bringing him to $99,500 and balancing the two accounts. 

Bank Reconciliation Statement

The following table shows an example of a bank reconciliation statement for Greg’s Lawnmowers:

Bank Balance:$88,000
Add: deposits in transit from four clients
+ $11,500
Nothing to subtract
Adjusted bank balance:$99,500
Book Balance:$100,000
Nothing to add
Subtract: bank fees
– $500
Adjusted book balance: $99,500

Bank Reconciliation Process Flow

The following 4 steps outline the basic process flow for completing a bank reconciliation.

1. Compare Statements

Begin with a side-by-side comparison of your bank account statement and your company’s accounting records. Check that your financial transaction records include all payments and deposits for the transaction period, as well as the final balance.

2. Identify Discrepancies

Go through both statements and highlight any transactions that appear on only one side. Note that transactions may take a few days to clear, so the transaction date in your financial records may not precisely match the date on your bank statement.

3. Make Adjustments

Once you have identified all the differences between the two statements, identify the source of the discrepancy. Common sources include deposits in transit that have not yet been deposited in your bank account, as well as bank fees that have been withdrawn by your bank but may have been missed in your company records. Adjust each statement to include these amounts.

4. Reconcile Balances

After including all the amounts identified in Step 3, your statements should display the same final balance. If any discrepancies cannot be identified and reconciled, it may signal an error or risk of fraud which your company can investigate further.

Benefits of Bank Reconciliation

Bank reconciliation is an important way for businesses to ensure that their financial records are accurate and up to date. It also helps maintain positive business relationships and simplify your business tax filing.

1. Ensures Financial Accuracy and Cash Flow

Keeping on top of your bank reconciliation ensures that you’re always aware of your company’s financial situation. This helps you anticipate any cash flow challenges so you can respond appropriately. Financial accuracy is also important for ensuring that all payments have been fulfilled and orders have been completed.

2. Improves Fraud and Error Detection

Conducting regular bank reconciliation helps you catch any fraud risks or financial errors before they become a larger problem. This includes everything from major fraud and theft to accounting miscalculations, insufficient funds, and incomplete or duplicated payments. 

Performing immediate bank reconciliations for large cash amounts or suspicious transactions further increases your ability to catch fraud and error.

3. Maintains Positive Client Relationships

Bank reconciliation isn’t just important for maintaining accurate business finances—it also ensures your customer and business relationships remain strong. Regular bank reconciliation double-checks that all payments have been accurately processed. This includes payments by customers to your company and payments from your company to employees, contractors, and other goods and services providers.

4. Simplifies Tax Filing and Financial Reporting

Maintaining accurate financial records makes it easier to organize your taxes when it comes time to file. Regular bank reconciliation saves you from having to review a full year of financial records—instead, you can quickly consult your reconciliation statements to review any required information.

Challenges With Bank Reconciliations

Discrepancies in bank reconciliations can arise from data processing errors or delays and unclear fees at the bank. Unpredictable interest income may also be a challenge when calculating financial statements, which can lead to challenges during a bank reconciliation.

1. Data Processing Errors

Human error in the data entry process can sometimes lead to incorrect amounts or miscalculations on a business’s financial statements. While it cannot entirely erase the potential for data processing errors, using accounting software can reduce the likelihood of errors to help generate more accurate financial statements.

2. Bank Delays

One of the most common causes of discrepancies in bank reconciliations is delays in deposit and transaction processing. Checks sent or received at the end of the day, or toward the end of the month, may be subject to delay which will prevent them from being included on the bank statement. Accounting for these delays is key to reconciling the total amounts on the company’s financial statement and the bank statement.

3. Bank Fees

Some bank services, including expedited payments, bank drafts, and in some cases paper bank statements, may come with additional bank fees. If a company is unaware of the exact amount of these fees, they may not be included in the company’s financial records and will only be seen when they receive their bank statement.

4. Interest and Investment Income

Income from variable sources like interest and investment may be difficult to predict. As such, exact amounts may not be accurately included on financial statements before the reconciliation process. When the business receives its bank statement, it can use the final amounts of interest and investment income to make adjustments and reconcile its financial statements.

What Should You Do if You Cannot Reconcile Your Account?

If you’ve followed the bank reconciliation process and accounted for all cash in transit, bank fees, and delayed payments, the total amount on your financial statement should match your bank statement. If this is not the case, the first step is to recheck both statements for any discrepancies that may have been missed. This can include things like:

  • Unpredictable income from interest and investments
  • Subscription renewal or one-time fees that may have been missed
  • Unexplained charges that may indicate fraud or theft

In cases where you discover discrepancies that cannot be explained by your financial statements, it’s best to contact your bank. It’s possible that a banking error has occurred or that you have been charged for something you were unaware of. If the charges are not from your bank, the bank can also help you identify the source so that you can prevent any fraud or theft risk.

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Simplify Your Accounting Process with FreshBooks

A bank reconciliation is an essential process for ensuring that your company’s financial statements match the available cash in your business bank account. Performing regular bank reconciliations helps you stay on top of cash flow, keep organized records for tax season, and minimize the risk of fraud and theft.

Keeping accurate financial statements is the easiest way to simplify your bank reconciliation process. FreshBooks accounting software helps you track income and expenses and generate reports and financial statements. Try FreshBooks for free to streamline your tax preparation and bank reconciliations today.

Michelle Payne, CPA
Michelle Payne, CPA

About the author

Michelle Payne has 15 years of experience as a Certified Public Accountant with a strong background in audit, tax, and consulting services. Michelle earned a Bachelor’s of Science and Accounting from Minnesota State University and has provided accounting support across a variety of industries, including retail, manufacturing, higher education, and professional services. She has more than five years of experience working with non-profit organizations in a finance capacity. Keep up with Michelle’s CPA career — and ultramarathoning endeavors — on LinkedIn.