What Is a Bank Reconciliation? How to Do One (2024)

Bank reconciliation is the process that companies use to make sure that the cash balancesthey show on their books matches the actual cash they have in the bank. Withcompanies’ increasing use of other entities to make and receive payments, it’sprobably wise to think of bank reconciliation as also applying to the cash that passesthrough these other entities, including online payment systems. But banks still hold theoverwhelming majority of business accounts and companies can use the same basic process theyuse in bank reconciliation to pinpoint their cash positions elsewhere.

What Is Bank Reconciliation?

In bank reconciliation, companies compare the balances and transactions on their externalbank statements to the cash balances and transactions recorded in the cash accounts of theirgeneral ledger — the “cash books”. They spot discrepancies and bring thetwo cash amounts into alignment by adjusting for as-yet unrecorded transactions, such asdeposits that have not yet cleared the banking system and new bank fees. Bankreconciliations are an important tool in cash-flow management and are usually handled by anaccounting department or a business owner.

Key Takeaways

• The cash balance on a company’s books almost never matches the bank statementbalances at the end of the month.
• Bank reconciliation is used to identify, justify and align these mismatches and providethe most accurate possible picture of cash flow.
• The reconciliation process requires business owners to understand some key accountingconcepts, such as NSF checks and deposits in transit.
• Bank reconciliations should be done on a regular basis so that conflicting itemsdon’t pile up, becoming more confusing and harder to fix.
• Software can help companies automate certain parts of the reconciliation process.

Bank Reconciliation Explained

The cash balance shown on a company’s internal balance sheet almost never matches theactual cash balance it has in its bank or other payment services. These discrepancies have avariety of causes, from timing issues in the course of normal business operations, to errorsand even fraud, and can vary in size from very small to the quite large. Bank reconciliationhas to do with identifying and settling these discrepancies in order to get an accuratepicture of the business’s available cash. It is an integral part of effectivecash-flow management and internal controls.

Why Is Bank Reconciliation Important?

A business’s investments in marketing, R&D and technology all depend on it havingthenecessary level of cash. Bank reconciliation is one of the processes that tells a company,at any given point in time, whether it’s in a position to fund something new or shouldhold back.

4 Reasons Bank Reconciliations Matter

Bank reconciliations are particularly important because they:

1. Pinpoint cash flow. A business needs to understand the amount ofmoney that is coming into its accounts as well as the amounts going out. Thatunderstanding is crucial both for small financial decisions — such as when torelease payment to a vendor — and for bigger decisions like whether to pay aspecial dividend to shareholders. A bank reconciliation provides a definitivepicture of your business’s available cash.

2. Foster business confidence. Incomplete or old data can lead toill-informed business decisions, such as a company paying a bill that itdoesn’t have the funds to cover, and the impaired relationship that may cause.If the cash view is flawed in the other direction — if it doesn’taccount, say, for a big payment that’s about to come in — the companymay be overly cautious about investing and may fail, for instance, to fill acritical open position or not buy an attractive asset that is available at a bargainprice.

3. Highlight potentially fraudulent activity. An item-by-item bankreconciliation reveals fraudulent activity quickly. Suppose a company has written acheck for $440 to a heating-repair company. If the company sees a debit on its bankstatement of $490 for that transaction, it immediately triggers a question aboutwhether someone had changed the amount.

4. Draw attention to accounts receivable problems. When done regularly,bank reconciliation can help identify issues with receivables — for example,unpaid invoices — and allow a company to take corrective action.

Who Should Oversee Bank Reconciliations?

Someone in a financial position — like a company’s controller or an accountingmanager — is usually responsible for overseeing the bank reconciliation process. Astaff accountant typically does the actual reconciling of the company’s accountingrecords and bank statements, in accordance with segregation of duties best practices. At abig company, there would typically be several people within the accounting department tohandle different account reconciliations. It’s common for the owner to do the bankreconciliation at a smaller company.

Bank Reconciliation Process Flow

The bank reconciliation process has three basic steps. The first is comparing the cashbalances and transactions on the company’s books to the cash balances and transactionslisted on an external bank statement. Because of things like electronic transfer fees,outstanding checks and deposits and different cut-off periods, the two rarely match.

In the second step you adjust both balances. Both the amount of cash in the bank account andthe amount of cash on the company’s books often change in this step as you account fortransactions reflected on the one but not the other.

In the third step you record the reconciliation. Basically, what you’re doing here isrecording a change to the cash accounts in your general ledger. The bank account balancewill adjust naturally as the transactions you identified in the second step move through thebanking system.

Important Terms to Know for Bank Reconciliation

There are many things that account for the differences between a company’s bankstatement and its accounting records. Three of those things have evolved into common termsyou may encounter at various stages of a bank reconciliation:

• Outstanding check. An outstanding check is when a company hasreceived but hasn’t yet deposited in the bank, or a deposited check thathasn’t yet been cleared through the banking system. It can also be a check acompany issued but that hasn’t been deposited by the recipient.

  See Also

  How To Do a Bank Reconciliation?(8 Steps With best practices)How To Get Your Bank Reconciliation Correct (With Examples)4 Bank Reconciliation Statement Problems & Solution ExampleHow To Reconcile A Bank Statement - DocuClipper

• NSF check. If a company tries to deposit a check from a customerthat doesn’t have the funds on account to cover the payment, the transactionfails. Non-sufficient funds (NSF) is bankers’ parlance for a“bounced” check. Either way, it means the money doesn’t end up inthe check recipient’s account. The payer is usually charged a fee for bouncinga check, and sometimes the recipient is, too.

• Deposit in transit. After a company gets a payment, especially inthe form of cash or checks, it needs to deposit the payment at the bank. If a cashdeposit is made at the end of the day, the money may not show up in thecompany’s bank account until the next day. This is considered a deposit intransit. Other delays — including a check that is mailed or still sitting atthe recipient’s office — also cause deposits in transit.

Benefits of Bank Reconciliation

Bank reconciliation is such a fundamental part of corporate accounting that the only realquestion for most companies is who does it and with what tools — not whether to do itin the first place. Among its biggest benefits, bank reconciliation:

• Ensures customer payments have been made. Fulfilling an order orcompleting a project is only part of running a business successfully. Businessesalso need to know that the payment is now available as cash in the bank. A bankreconciliation is how you make sure of this.

• Simplifies accounting. As they grow, most companies opt for the accrual method ofaccounting, in which revenue and expenses are recorded when the relevantactivities occur, versus when the cash comes in or goes out. The accrual method,required by GAAP, is seen by manyaccountants as providing the most realistic picture of a company’s financialposition, and is usually required by the IRS for companies that hold inventories.Bank reconciliation is indispensable to accrual accounting.

  Companies that use cash accounting — recording transactions at the same timethe bank does — still need bank reconciliation. For example, take a companythat pays its employees through paper checks instead of automatic deposits. The timeit takes checks to clear — or employees to deposit those checks — meansthat on paydays there will be a mismatch between the company’s books and itsbank account.

• Catches errors. Bank reconciliation helps companies spot bank errorsas well as those made by internal staff on the general ledger. Although bank accounterrors are not common, they do happen. On the general ledger side, there tend to befar more errors in organizations that use more manual business accounting processes.

• Draws attention to cash-flow problems. A company that takes adisciplined approach to bank reconciliations — and that does them on a setschedule — often has an advantage in spotting cash-flowissues. With this early view of a potential problem, a company can takesteps to minimize any disruption to its business.

Challenges With Bank Reconciliations

In trying to resolve the mismatches between their books and their bank statements,accountants tend to look for a few different causes. The most common are:

• Uncleared checks. These are payments that have been sent out buthave not yet cleared through the banking system. Accountants adjust for them duringreconciliation. Similarly, customer checks received and applied by the business maynot yet have cleared the banking system.

• Voided checks clearing. If a check your company voided subsequentlyclears the bank, the charge must be recorded. This is not a common occurrence butdoes happen. It’s something you would catch and adjust as part of a bankreconciliation.

• Returned deposited checks. This refers to a payment that cannot beprocessed by the banking system. The cause can lie with a customer making a payment,for example, if the customer has insufficient funds in its account, has put a stoporder on the payment or has made a mistake such as failing to sign the check. It canalso lie with a recipient company if, for instance, the company has neglected todeposit the check until it’s more than six months old. Whatever the cause,returned deposited checks require adjustments during the bank reconciliationprocess.

• Bank service fees. Many bank services carry a fee, including forvarious account services and for electronic or expedited payments. The precise levelof these fees sometimes isn’t known until they appear in companies’ bankstatements, at which point they require an adjustment to a company’s books.

• Interest income. This is another number that isn’t alwaysclear before it shows up on a company’s bank statement. The amount is added tothe company’s books during reconciliation.

How to Do Bank Reconciliations Step by Step

Companies can assign different people to handle different parts of a bank reconciliation andcan complete reconciliations in a number of different ways. The basic sequence, however,consists of the following six steps.

1. Compare the bank account balance to the cash balance on your books.The first step in a bank reconciliation is to look at the bank account statement andbookkeeping record side by side. For most businesses, the cash balances are notgoing to be the same. The difference could be a few hundred dollars, a few thousanddollars, or more depending on the size of the business and the type and magnitude ofany unreconciled transactions.

   See Also

   How to Perform A Three Way Reconciliation

2. Scrutinize your bank statement. In this step, you are looking forthe line items on the bank statement that aren’t reflected in the bookkeepingof the company’s cash accounts. Bank fees are an example of an item on thebank statement that may not be in the accounting records.

3. Scrutinize your cash book. Next you want to figure out the cash-inor cash-out transactions that are on the company’s books but not listed on thebank statement. This may include deposits or payments recorded or made on the firstor last day of the period that have not yet cleared. It may also include checkswritten that haven’t reached their recipients, or that the recipientshaven’t deposited.

4. Adjust the balance of your bank account. After identifyingtransactions in the general ledger that haven’t yet been processed by thebank, you can figure out how the balance in your bank account is expected to changein the next few days or as those transactions are recorded by the bank. Outstandingdeposits will increase the amount of cash. Outstanding withdrawals decrease the cashin your bank account.

5. Adjust the balance of your books. This is similar to step four, buthere you manually adjust the company’s book balance for any unmatchedtransactions listed on the bank statement. Some of the transactions listed in thebank account, such as interest payments, will increase the balance on your books.Other transactions, like bank fees, will decrease the cash shown on your books.

6. Record the reconciliation. There are two ways to record areconciliation, both of which apply only to the company’s books, not its bankaccount. The first is to put a simple note at the bottom of the cash bookcategorizing each discrepancy and showing the aggregate discrepancy in eachcategory. The second is to compile a bank reconciliation statement. This is a moredetailed document that shows the reason for each discrepancy from the bank balance.Where a cash book note might only show there was $100 worth of NSF checks in a givenmonth, the bank reconciliation statement would break down the bounced checks bydate, amount and payer.

Example of a Bank Reconciliation

A hypothetical San Francisco home contractor, By the Bay Contracting, is doing areconciliation at the end of January. By the Bay’s bank account shows $106,800 butthere is $120,000 in cash on the company’s books. The company’s accountant setsabout reconciling the discrepancy. She notices $200 worth of bank fees that aren’treflected on the company’s books and $13,000 worth of deposits in transit —checks from three separate home renovation clients that were received earlier in the weekbut that have not been deposited at the bank.

The accountant calculates that the bank account balance is going to end up at $119,800 onceit includes the $13,000 of deposits in transit. At the same time, the cash balance of$120,000 on the company’s books will go down by the $200 in bank fees. She creates abank reconciliation statement that itemizes both the $200 in unrecorded bank fees and the$13,000 in outstanding deposits.

Bank Reconciliation Statement

Here’s an example of how By the Bay Contracting’s bank reconciliation would look.

Tips for Successful Bank Reconciliations

Best practices in bank reconciliation vary from business to business, especially as a companygrows and its operations become more complex. The following tips, however, can be applied toany organization’s bank reconciliations.

• Do bank reconciliations on a set schedule. Reconciliations aretime-consuming and confusing if not done regularly. A delay in reconciling can wipeout some of the benefits bank reconciliations offer, such as spotting cash-flowproblems in a timely way. As a result, smart businesses do monthly or even weeklybank reconciliations. A high-volume business such as a retail store or restaurantmay well do bank reconciliations daily, a feature supported by some accountingsoftware that can automatically link to and download information from banks in realtime.

• Consolidate accounts. If there is so little activity in an accountthat there is sometimes nothing to reconcile, consider closing the account andmoving the funds to a more active account. This will make your bank reconciliationprocess more efficient.

• Take advantage of technology. As businesses grow and do moretransactions, bank reconciliation becomes an increasingly complex, time-consumingprocess. Though accountants are certainly needed to check data and make judgments,there are also aspects of bank reconciliation that can be automated. Companiesshould look for software to help with this, particularly as the need for remotework increases.

Manage Bank Reconciliations With NetSuite

For companies with high transaction volumes, multiple bank accounts or multiple currencies,bank reconciliation can be a time-consuming process. NetSuite CashManagement can automate a crucial part of this process — the manual comparisonof bank data with companies’ accounting system data. NetSuite users canautomatically import bank data, saving time and improving accuracy. For instance,the MD Restaurant Group, a chain based in Illinois, is using NetSuite’s bankreconciliation functionality to compare financials from 19 different entities.

Bank reconciliation aligns the cash balances on a company’s bank statements with thecash balances it has on its books. It is an essential part of corporate accounting. Amongthe benefits of bank reconciliation are better cash-flow management, better management ofaccounts receivable and a better ability to spot fraud. The right steps and technologies canhelp companies increase the speed and efficiency of their bank reconciliation processes,regaining time for other activities.

Bank Reconciliation FAQs