Bank reconciliations are a crucial part of any business. Small business owners should be reconciling their bank statements once a month, at a minimum. For larger businesses, you may need to perform daily bank reconciliations.
In addition to being a necessary check and balance, the reconciliation process also offers you the opportunity to see your business's actual cash flow. It provides you with a better understanding of the timing of your business's collections and spending, and it helps you stay on top of your accounts receivable and accounts payable.
What Is a Bank Reconciliation?
A bank reconciliation compares the cash account from your business's general ledger to the ending balance on the bank statement for the same time period. When you perform a bank reconciliation, you are ensuring your business records have captured all cash transactions accurately. It is also an opportunity to double check your bank's records to identify any errors in the transactions in your bank account.
Differences in the cash account balance and bank statement balance are common. Not all differences signal an error or fraudulent activity. Many are the result of timing differences or small fees directly assessed in the bank account. However, if you do find any discrepancies in the records, it is important to resolve the issue during the reconciliation process. At the end of the reconciliation, your adjusted bank balance should equal your adjusted cash account balance.
Step-By-Step Guide to Reconcile Your Bank Statement
You receive your bank statement from your business's financial institution on a recurring basis, typically monthly. The bank statement itemizes everything you deposited into or withdrew from your account in a certain time frame. When you receive this statement, it is time to start on your bank reconciliation.
1. Compare Balances
Gather your accounting records for the time period covered by the bank statement. You should compare the deposits and withdrawals from the bank statement to the debits and credits in your cash account. Remember that debits increase your cash account, like a deposit or income, and credits decrease your cash account, like a withdrawal or fee.
2. Identify Differences
Some differences in timing are normal and expected, such as deposits in transit and outstanding checks. Deposits in transit are amounts received by your business and recorded in your books that haven't yet been recorded by the bank. Outstanding checks have been issued by your business but haven't cleared the bank yet. The same thing can happen with electronic fund transfers initiated at the end of the month.
Additionally, it is common for your bank to deduct fees and penalties and add interest income directly to your bank account. Unless you are tracking your bank account balance on a daily basis, your business may not have recorded these transactions on its books prior to the reconciliation process.
3. Resolve Any Issues
Other items require more effort to resolve. Here are some common issues that arise during a bank reconciliation.
- Voided checks that cleared your bank account. A check you have previously voided on your books may be cashed by the recipient and clear your bank account. If this happens, you will need to credit the amount to your cash account.
- Transactions processed by your bank twice. If one check erroneously clears your bank account twice, you will need to inform the bank of the error. If you've voided and reissued a check, and both checks clear your bank account, you will need to credit the amount to your cash account for the voided check. However, in this situation, you should also contact the recipient to work out a repayment for the overpayment.
- Errors in bank records or your records. The bank may clear a transaction for an incorrect amount, or your cash account may have an error in the original entry. You can catch a number of issues during a reconciliation. For example, an "8" could appear as a "0" to someone manually recording an item, two numbers could be reversed, or a decimal point may be moved over one or more digits. If it is an error on the bank's side, contact them. If it is an error on your own records, you will need to do an adjusting journal entry.
- Older outstanding checks that need to be voided. Recently issued checks will still be outstanding, and that is normal and expected. If you issued checks on the last day of the month, it is unlikely that all of the recipients would have already cashed them. However, if a check remains outstanding for many months, it signals an issue. You should reach out to the intended recipient and see if you need to void and reissue the check.
4. Adjust Balances
First, adjust the bank balance by adding in deposits in transit, subtracting outstanding checks, and adjusting for any bank errors that you have identified during the reconciliation process.
Second, you need to adjust the cash account balance. You will need to add in bank fees or penalties and subtract interest income that has been recorded by your bank. If any errors were made in the accounting records, they will need to be adjusted here as well.
5. Compare Balances
After you have adjusted the bank balance and cash account balance, the two should match. If the adjusted balances still don't match, go back through the previous steps to identify the discrepancy.
6. Book Adjusting Journal Entries
After the adjusted balances match or are "reconciled," you should record any necessary adjusting journal entries to modify the cash account in your general ledger. You should make an adjusting journal entry for any transaction recorded in your adjusted cash account balance in step 4. Items you may need to adjust include:
- Bank fees or penalties recorded by your bank. You should credit these to decrease your cash account.
- Interest income recorded by your bank. You should debit these to increase your cash account.
If you found a discrepancy due to an error on your books, this would be the time to make those adjustments as well.