The Importance of Bank Reconciliations
A bank reconciliation, commonly referred to as a “bank rec” by the cool kids, is the process of comparing transactions in your internal accounting system to your actual bank or credit card statements.
To understand why bank recs are important, we need to quickly highlight how bookkeeping happens. Bookkeeping is the process of recording every single transaction, whether on a bank statement, credit card statement or other source (cash) and categorizing it to a specific account, for reporting purposes. For example, a payment to a landlord would be recorded as funds withdrawn (i.e. cash balance is reduced) and categorized to ‘Rent expense’.
To ensure that all transactions have been accounted for properly for a given period (like the rent payment discussed above), a bank rec exercise is performed (usually monthly). As mentioned above, the internal accounting system’s transactions are compared to the actual bank or credit card statement and the end result is that for the most part, they should mirror each other. When they don’t, an investigation needs to be had, and adjustments, if necessary, need to be made.
A bank rec should provide you with comfort over your general ledger balance (accounting system) and how it ties to the ending balance of your bank or credit card statement. You should be able to understand why the accounting system bank and credit card balances differ from your actual bank and credit card balances. If you don’t, you should investigate or hire someone to help.
Bank reconciliations have multiple objectives:
Ensures accuracy of transactions (i.e. are amounts recorded correctly)
Ensures the existence of transactions (i.e. are amounts appearing on the bank or credit card statement are showing up in the accounting system and vice versa)
Catching fraud before it’s too late
Catching other errors or issues (i.e. bounced payments, banking errors, miscellaneous fees)
THE MECHANICS OF A BANK REC
Gone are the days where software wasn’t part of our lives and bank recs were manual. With cloud accounting apps, bank transactions automatically feed into the accounting system and transactions are recorded (whether automatically through a live bank feed or a quick import). If there are no issues, then the software should be able to produce a bank rec report for you that gives you a summary of the bank and accounting system balances and any differences, which you can verify for accuracy.
Here is a bank rec from Xero. As you can see, this company has some work to do since they have outstanding items from 2018 on their January 31, 2020 bank rec report. Their accountant can’t be happy about this!
We can easily see in this bank reconciliation that the difference between the ‘Statement Balance’ (i.e. the actual bank statement) and ‘Balance in Xero’ (i.e. the balance in the accounting system) relates to various transactions that have not been recorded. Once they are recorded, the ‘Statement Balance’ and ‘Balance in Xero’ will match.
A bank rec is an extremely important process to undertake since it can ensure that all bank and credit card transactions are accounted for. Although accuracy and reporting is important, bank recs can help curb fraud. If you investigate your bank rec reports, looking at cheques, transfers and other transactions, you will be able to spot issues more quickly.
BANK RECS AND ACCOUNTING
Fraud aside, bank recs are an important tool for ensuring accuracy. Whether it’s for tax reporting purposes, KPIs (Key Performance Indicators) or periodic reporting - internally or externally to boards and investors - you need to ensure your books are an accurate reflection of your business.
For example, if deposits weren’t recorded accurately or recorded at all, revenues may be understated. This omission impacts performance metrics (you might be wondering why revenue for a given period is lower than forecasted) and tax reporting (presumably, you would be paying less tax since revenue is lower). When and if corrected at a later date, your tax submission would have to be amended, perhaps resulting in interest and/or penalties. If the omission is significant, the interest/penalties may be substantial, but worse, the tax authorities may contact you, and who knows where that can lead. Let’s not even go there - just do your bank recs!
Other areas that can be impacted if consistent bank recs are not performed:
Missing expenses - similar to our revenue example above, this can impact performance metrics and tax reporting
Sales tax implications - by missing sales tax collected on revenue or incurred on expenses, you may be misreporting your sales tax numbers to the tax authorities, resulting in interest/penalties
Personal tax implications - if dividends or shareholder transactions are not recorded accurately
Cash flow management
BANK REC CLEAN-UP
Part of what we do here at ConnectCPA is create the financial architecture for companies by moving them from various accounting systems to Xero. Through our ‘conversion’ and ‘onboarding’ process we have come across unbalanced books numerous times. The issue with unbalanced/unreconciled accounts is that when business owners are ready to get serious about their books, it takes time to investigate, back-track and clean-up.
Furthermore, aside from accounting clean-up jobs taking time, they can also be quite costly. If a multiple year clean-up is required, which is not uncommon, the costs will add up.
When accounts are not reconciled properly, there is temptation to create a one-time entry or ‘plug’ to balance things out. Taking a shortcut such as this should carefully be considered since adjustments such as these can skew the accounting records, which will then be reflected in inaccurate tax filings. Depending on the situation, it can work, but you should speak to a professional before attempting this.
Last but not least, if business owners do decide to ‘clean up’ the books, due to the time lag between the actual transactions occurring and the reconciliations taking place, many explanations for transactions can be forgotten (i.e. is this bank withdrawal an expense? Or was it a shareholder repayment? - those are two wildly different things with significant and different implications).
FINAL THOUGHTS
The importance of bank recs cannot be overstated due to the value that they provide. Your business will thank you. The frequency of bank reconciliations depends on the transaction volume of a business. Although many businesses opt to perform bank recs monthly, there are many situations where you may decide that weekly or even daily bank recs make sense. Whatever frequency you choose, just ensure one thing - that they are being done!
