What is bank reconciliation? Guide to accurate books and finance

Bank reconciliation is an essential process for your business. Get it right, and you’re well on your way to being on top of your finances. Get it wrong, and you could end up paying more tax than you should.

Think of bank reconciliation as a regular check-up for your business's money. When you get it right, you'll have a clear picture of your finances. Mess it up, and it could cost you more than it should at tax time. 

While the basics are pretty simple, things can get tricky. This guide will walk you through some of those more complex situations, showing you the best ways to keep things in order and how to use reconciliation to really understand your business's financial health.

What is bank reconciliation?

Bank reconciliation is the process of aligning your financial records with your bank's monthly statements. This routine check ensures both records match, helping you spot any discrepancies, errors, or fraud. 

It's a vital financial health check for your business, providing clear insight into your finances. Accurate reconciliation prevents tax overpayments and aids in sound financial decisions. Skipping this step can lead to inaccurate financial reports and potential financial consequences.

Why is bank reconciliation important?

Bank reconciliation is vital for businesses, offering several benefits beyond balancing the books. It involves matching a company’s financial records with bank statements. This ensures accuracy, transparency, and sound financial management.

Spotting mistakes and errors

Reconciliation helps identify errors such as missing transactions, incorrect entries, and timing differences. Missing transactions occur when payments show in company records but are not yet on bank statements or vice versa. Incorrect entries happen due to miss-entries or technical glitches. Timing differences, like uncashed checks, aren't errors but need awareness for accurate cash status.

Preventing fraud

Regular reconciliation helps catch fraudulent transactions quickly. It identifies unauthorized payments, fake records, and changes to transaction details. By spotting these early, businesses can investigate and reduce financial risks.

Ensuring accuracy

Accurate reconciliation ensures complete records and verifies true balances. It allows businesses to keep their financial records current, directly supporting better financial decisions and stakeholder trust.

Supporting financial statements

Reconciliation is key for reliable financial reports, ensuring accurate cash balances, integral to the balance sheet. This precision supports compliance, investment decisions, and trend analysis, giving a true financial picture.

Aiding tax compliance

Reconciliation helps accurate tax filings by confirming all income and expenses are recorded correctly, reducing error risks and penalties. It maintains clear records for tax inquiries, making tax compliance easier.

Enhancing tax and audit readiness

Accurate reconciliation affects tax returns and audits. It ensures:

• VAT and corporation tax returns are accurate.
• A solid audit trail is maintained for compliance and verification.

Revealing common fraud

Reconciliation can uncover fraud such as unauthorized withdrawals, check fraud, and employee embezzlement. Finding irregularities in transactions aids in fraud detection and prevention.

Knowing your true cash position

By understanding the true cash position, businesses avoid chasing already settled invoices and maintaining professional customer relationships.

Boosting cash flow projection

Reconciled data is crucial for cash flow management, enabling better forecasting and planning for potential shortfalls.

Bank reconciliation process: How bank reconciliation works

The bank reconciliation process is a systematic way to compare your business’s internal financial records with the monthly statements provided by your bank. It ensures that both sets of records match, which is crucial for accuracy and preventing fraud. Here’s a breakdown of how it works:

1. Gathering all necessary bank statements

Collecting all relevant bank statements is the next step. This includes statements for all current accounts, credit cards, and any payment processor statements like Stripe or PayPal, if applicable. Ensure you have the most recent statements that align with your chosen cut-off point.

2. Having your accounting system/cash book ready

Before starting the reconciliation, ensure your accounting system or cash book is up-to-date. All internal records should be entered and accurate up to the cut-off point. This preparation will streamline the reconciliation process and make it easier to identify discrepancies.

2.1 Gather records

This step involves collecting all your internal financial records, such as your cash book, accounting software data, and any receipts or invoices.

2.2 How-to details

1. Ensure all transactions have been entered into your accounting system or cash book.
2. Organize records chronologically for easier comparison.
3. Print out relevant reports from your accounting software for the period you are reconciling.

2.3 What to look for

• Missing entries or duplicate entries.
• Transactions that have not been correctly categorized.
• Receipts or invoices that have not been recorded.

3. Compare deposits

Compare the deposits listed on your bank statement with those recorded in your cash book or accounting system.

3.1 How-to details

1. Match each deposit on the bank statement with a corresponding entry in your records.
2. Check amounts and dates to ensure they align exactly.
3. Tick off each matching deposit in both your records and the bank statement.

3.2 What to look for

• Deposits recorded in your records but not on the bank statement (outstanding deposits).
• Deposits on the bank statement that are not in your records (unrecorded deposits).
• Differences in deposit amounts or dates.

4. Adjust bank statements

Adjust the bank statement for items that are not yet reflected in your internal records, such as bank fees or interest earned.

4.1 How-to details

1. Add or subtract any bank charges, fees, interest earned, or direct debits that are on the bank statement but not in your records.
2. Make notes of each adjustment for future reference.
3. Update your internal records later to reflect these adjustments.

4.2 What to look for

• Bank service charges.
• Interest credited or debited.
• NSF (non-sufficient funds) fees.
• Electronic funds transfers (EFTs).

5. Adjust cash account

Adjust your cash account for items that are in your records but not yet reflected in the bank statement, such as outstanding checks.

5.1 How-to details

1. Add or subtract any outstanding checks or deposits in transit that are in your records but not on the bank statement.
2. Document each adjustment with details of the transaction.
3. Ensure these adjustments are reflected in your next reconciliation.

5.2 What to look for

• Checks you’ve written that haven't been cashed yet.
• Deposits you’ve made that haven’t cleared the bank yet.
• Any errors in recording transactions internally.

6. Compare balances

After making adjustments, compare the adjusted bank statement balance with your adjusted cash account balance. They should match.

6.1 How-to details

1. Calculate the adjusted balance for both the bank statement and your cash account.
2. If the balances match, the reconciliation is successful.
3. If they don’t match, recheck all steps and look for errors.

6.2 What to look for

• Large discrepancies may indicate significant errors.
• Persistent differences that might point to a systematic issue.
• Unresolved items that require further investigation.
  
  

Bank reconciliation examples

The following examples show how correct bank record reconciliation can help a business and the risks of reconciling a checking account can help avoid.

Example 1: Missing deposit

A business deposits a check for $1,000 USD into its online banking account. However, when they reconcile their bank statement, they notice that the deposit is not listed.

The business investigates and discovers that the check was processed by the bank, but it was not credited to their account. They contact the bank and provide a copy of the deposit slip. The bank corrects the bank error and credits the $1,000 USD to the business's account.

Example 2: Unauthorised withdrawal

A business reconciles its book balances and bank statements and notices a withdrawal for $500 that they do not recognize. They investigate and discover that the withdrawal was made by a fraudulent charge on their credit card.

The business contacts their credit card company and disputes the charge. The credit card company investigates and determines that the charge was fraudulent. They credit the $500 USD back to the business's account.

Example 3: Incorrect charge

A business reconciles its bank statement and notices a charge for $100 USD from a vendor that they do not recognize. They investigate and discover that the charge was for a product that they never ordered.

The business contacts the vendor and disputes the charge. The vendor investigates and determines that the charge was made in error. They credit the $100 USD back to the business's account.

Types of bank account reconciliation

Bank account reconciliation varies depending on the industry, financial structure, and type of business. Here are some common types:

1. Periodic bank reconciliation: Involves regularly comparing your bank statement to your own records, typically monthly or quarterly. It helps identify and rectify discrepancies, ensuring your financial records are accurate and current.

2. Continuous bank reconciliation: Continuous matching of your bank statement with your records, allowing for faster identification and correction of errors, and maintaining up-to-date financial oversight.

3. Inter-company bank reconciliation: Entails comparing the bank accounts of related companies to ensure alignment, verifying that inter-company transactions are accurately recorded without discrepancies.

4. Fixed asset bank reconciliation: Checks the alignment between the fixed assets on a company's balance sheet and records from the bank or financial institution holding these assets, ensuring all fixed assets are accurately accounted for in financial records.

5. Accounts receivable bank reconciliation: Involves matching accounts receivable records with bank statements to ensure customer payments are correctly recorded and deposited, spotting discrepancies to maintain precise financial records.

6. Credit card reconciliation: This type involves comparing credit card statements with company payment records. It ensures that all credit card transactions are properly recorded and any unauthorized charges are quickly identified and disputed.

7. Petty cash reconciliation: Focuses on verifying that petty cash transactions are accurately recorded and that the physical cash on hand matches the balance expected from the records. It's crucial for preventing the misuse of funds.

8. Vendor account reconciliation: Ensures that payments and records of purchases from vendors match what is stated in the bank account. This reconciliation helps in maintaining good relationships with vendors by ensuring there are no payment discrepancies.

Maintaining regular reconciliation practices not only enhances the accuracy of your financial reporting but also plays a crucial role in behavioral financial oversight and control.

Manual bank reconciliation vs automated bank reconciliation

Bank reconciliation can be performed using either manual or automated methods. Each approach has distinct advantages and disadvantages that businesses should consider when choosing the most suitable method for their needs. 

The following section explores the key differences between manual and automated bank reconciliation, outlining the pros and cons of each to help businesses make informed decisions.

What is manual bank reconciliation?

Manual bank reconciliation involves comparing your bank statements against your internal records line by line. This is typically done using spreadsheets or paper records. It requires careful attention to detail, as each transaction must be checked and matched manually. While it can be time-consuming, manual reconciliation allows for a very hands-on approach, giving you a deep understanding of your transactions.

Advantages of manual bank reconciliation

• Provides a thorough understanding of transactions.
• Can be done with basic tools like spreadsheets.
• May be suitable for businesses with a low volume of transactions.

Disadvantages of manual bank reconciliation

• Time-consuming and labor-intensive.
• Higher risk of human error.
• Can be difficult to scale as the business grows.

What is automated bank reconciliation?

Automated bank reconciliation uses accounting software or specialized tools to match transactions between your bank statements and your internal records. The software automatically imports bank data and attempts to match it with your entries, reducing the need for manual checking. This process is faster and more efficient, freeing up time for other tasks.

Advantages of automated bank reconciliation

• Saves time and reduces manual labor.
• Minimizes the risk of human error.
• Scalable and efficient for high-volume transactions.
• Provides real-time insights into your cash flow.

Disadvantages of automated bank reconciliation

• Requires investment in accounting software or tools.
• May still require manual intervention for complex or unmatched transactions.
• Initial setup can be time-consuming.
  
  

Key differences between manual and automated bank reconciliation

Choosing the right method for your business

The choice between manual and automated bank reconciliation depends on several factors, including the size of your business, the volume of transactions, your budget, and your comfort level with technology.

Businesses with few transactions may find manual reconciliation sufficient. However, as a business grows, automated reconciliation becomes increasingly necessary to manage the workload and ensure accuracy.

Dealing with common bank reconciliation discrepancies

When performing bank reconciliation, it's common to encounter discrepancies between your records and the bank statement. Here’s how to deal with some of the most frequent issues:

When are deposits in transit a concern?

Deposits in transit are payments you’ve recorded but haven't yet shown up on the bank statement. This is usually due to the time it takes for the bank to process the deposit. They become a concern if they remain outstanding for an unusually long time. If a deposit is in transit for several days beyond the typical processing time, it might indicate an error or a lost deposit that requires investigation.

How long to keep un-presented checks as outstanding?

Unpresented checks, though less common now, still exist. These are checks you’ve issued but haven’t been cashed by the recipient. You should keep them outstanding on your reconciliation until they are presented or become significantly old (usually after six months). After this period, it’s a good practice to cancel and reissue the check if necessary.

Identifying different types of bank charges and fees

Bank charges and fees can vary and need to be correctly identified. These may include:

• Monthly fees: Regular charges for maintaining the account.
• Transaction fees: Charges for each transaction, such as withdrawals or transfers.
• Overdraft interest: Interest charged when the account balance goes below zero.

Ensure each type is correctly recorded to get an accurate view of your expenses.

Interest earned (if applicable)

If your account earns interest, ensure it’s recorded accurately. Interest earned should appear on the bank statement and be added to your internal records.

Ensuring direct debits & standing orders match expected amounts and are correctly recorded

Direct debits and standing orders should be checked to ensure they match the expected amounts and are correctly recorded. If there are discrepancies, contact the relevant parties to resolve them. This helps prevent errors and unauthorized payments.

Understanding delays between your record and the bank statement for BACS/Faster payments timings

Delays between your record and the bank statement for BACS and Faster payments can occur. Understand the typical processing times for these payment methods. If there’s an unexpected delay, follow up with the bank or payment originator to clarify.

Reconciling net payouts after fees from payment processor payouts (e.g., Stripe, PayPal)

When reconciling payment processor payouts like Stripe or PayPal, focus on reconciling the net payouts after fees. The bank statement will usually show the net amount deposited. Compare this to the settlement reports from the payment processor, which will detail gross transactions and fees deducted.

When your bank reconciliation still doesn't balance

Sometimes, despite careful work, your bank reconciliation might not balance. This can be frustrating but it's usually solvable with a systematic approach. Here’s how to tackle common reconciliation issues.

Common culprits

When a bank reconciliation doesn't balance, certain errors are frequently to blame.

• Transposition errors: These happen when numbers are mixed up, for example: Say you paid a supplier £321 GBP but entered £312 GBP in your books — that £9 GBP difference is your clue (and yes, it's divisible by 9, which is the telltale sign of a transposition error).
• Omissions: Occasionally, a transaction might be missed entirely from either the cash book or the bank statement. While it’s rare for banks to miss transactions, it’s possible to overlook entries in your own records. Double-check both to make sure everything is accounted for.
• Duplicates: Sometimes, a transaction can be entered twice in the cash book. This will throw off your reconciliation and should be checked for.
• Incorrect starting balance: An incorrect starting balance is often the root cause of discrepancies, especially if it's the first reconciliation or if a previous one was not completed correctly. Ensure the opening balance matches the closing balance of the previous reconciliation.

Systematic checks

When you encounter a reconciliation problem, use a systematic approach to track down the error.

• Tick and bash: This involves going line by line through the bank statement and the cash book, ticking off each matching transaction. This methodical approach can help identify any discrepancies or missed items.
• Checking by transaction type: Try reconciling all income first, then all payments. This helps to organize your checks and can make discrepancies more obvious.
• Is the difference a single transaction amount?: See if the difference between your balances matches the exact amount of a specific transaction. This could point to a transaction that was only recorded on one side and not the other.
• Halve the difference: If you've entered a debit as a credit, or vice-versa, the difference might be double the transaction amount. Halve the difference and see if that number matches an entry.
  
  

Bank reconciliation best practices

Reconcile regularly for accuracy

Reconciling monthly is the minimum, but weekly or even daily reconciliation is better, especially when using bank feeds. Regular reconciliation helps in quickly identifying and addressing any discrepancies. With bank feeds, transactions are automatically imported into your accounting software, making more frequent reconciliation feasible and efficient. This keeps your financial data current and minimizes the risk of accumulated errors.

Ensure segregation of duties

Ideally, the person performing the bank reconciliation should not be the same individual handling all cash receipts and payments. Segregating these duties reduces the risk of fraud and errors. Having different individuals responsible for these tasks provides a system of checks and balances. This separation ensures that transactions are accurately recorded and any discrepancies are more easily identified.

Tips for smaller businesses?

For small businesses, especially sole traders, where full segregation of duties might not be feasible, implement compensating controls. This could involve having a trusted advisor, business partner, or even a family member periodically review the bank reconciliation and financial records. Utilizing bank feeds and setting up alerts for unusual activity can also provide an extra layer of oversight. Maintaining meticulous records and regularly reviewing them personally remains crucial for detecting errors or potential issues.

Review and sign off on the reconciliation

Have a director or manager review and sign off on the bank reconciliation each time it's completed. This review ensures an extra layer of scrutiny and accountability. It verifies that the reconciliation has been performed accurately and all discrepancies have been addressed. Sign-off also provides a documented record of the review, which can be helpful for audits and internal controls.

Investigate discrepancies promptly

Do not let errors or unidentified items linger. Investigate any discrepancies promptly to prevent further complications. Delayed investigation can make it harder to trace the origins of errors, leading to more time-consuming corrections later. Immediately addressing issues ensures that your financial records remain accurate and up-to-date.

Keep clear and secure records

File all reconciliation statements securely for audit and HMRC purposes. Maintaining organized and accessible records is essential for compliance and future reference. Electronic copies should be backed up, and physical copies should be stored in a secure location. Clear records provide a detailed audit trail, making it easier to resolve any queries and demonstrate financial accuracy.

Staying compliant with bank reconciliation

Accurate bank reconciliation supports accurate bookkeeping, which is essential for several compliance aspects. Here are some key factors:

How bank reconciliation supports accurate bookkeeping

Maintaining precise financial records hinges on the accuracy of bank reconciliation. By consistently comparing internal records with bank statements, any errors, omissions, or unauthorized transactions are identified. This process ensures that your financial data reflects the actual state of your accounts. The benefits of accurate bookkeeping are manifold, playing a pivotal role in tax compliance and audits.

Correct VAT calculations and Making Tax Digital (MTD) submissions

Accurate bank reconciliation confirms that VAT filings accurately reflect all transactions. Matching internal records with bank statements is crucial to prevent either over or underpayment of VAT. With the implementation of Making Tax Digital in the UK, businesses are required to maintain digital records and submit VAT returns using compatible software. 

Precise bank reconciliation feeds directly into this digital record-keeping, ensuring MTD submissions are based on reliable data. Errors in the underlying data due to neglected bank reconciliation can lead to penalties and inaccuracies in reporting.

Accurate corporation tax or self-assessment returns

For businesses liable for corporation tax, or individuals submitting self-assessment returns, bank reconciliation is vital for ensuring tax filings are based on the true financial position of the entity. 

Correctly reconciled accounts provide the necessary data to determine the correct taxable income. Errors or omissions in records can lead to inaccuracies, potentially resulting in penalties and tax disputes. Using reconciled data ensures that the tax returns are an honest representation of financial activities.

Providing evidence during any HMRC enquiries

In the event of an HMRC enquiry, having well-reconciled accounts provides a detailed and traceable record of all financial activities. This solid audit trail is essential for proving compliance and demonstrating that financial affairs are in order. 

Properly reconciled bank statements and accounting records can serve as crucial evidence to support the figures declared in tax returns and other official filings. Having these records readily available and in good order can help resolve enquiries efficiently, reducing stress and potential penalties.

By staying on top of bank reconciliation, businesses and individuals not only ensure their financial accuracy but also protect themselves from compliance issues, making it a cornerstone of sound financial management.

Beyond compliant: Using bank reconciliation strategically

Often bank reconciliation is seen as a chore to meet compliance requirements. However, by shifting this mindset, it can be leveraged as a potent management tool. Regular, strategic reconciliation provides a window into the operational pulse of the business, offering insights beyond mere transaction matching. It transforms a routine task into a proactive approach to financial management and planning.

How bank reconciliation informs cash flow management

Reconciled data gives a clear picture of actual cash flows. It moves beyond accounting records to reflect what is truly happening in the bank account. This live view helps in understanding timing differences, the velocity of cash in and out of the business, and allows for more agile management of short-term liquidity. Tracking consistent variances between accounting and bank records can point to systemic cash flow issues.

Understanding true available cash for operational decisions, investments, or managing upcoming accounts receivable efforts

The reconciled cash balance provides a realistic gauge of available funds. This is crucial for decision-making on day-to-day operations, potential investments, or planning accounts receivable (AR) efforts. Businesses can avoid overspending or missed opportunities due to reliance on inaccurate, outdated data. Knowing the true available cash allows businesses to make informed choices regarding expenditures, savings, and debt management. This clarity can give confidence to managers when planning and executing financial strategies.

Validating the effectiveness of credit control – are chased payments clearing promptly?

By comparing anticipated receipts based on accounts receivable with actual deposits, you can validate the effectiveness of your credit control measures. If reconciliation shows that payment receipt is lagging despite chasing efforts, it might indicate a need to review credit policies or improve follow-up processes. Quick payment clearances, visible through rapid reconciliation, confirm that credit control procedures are working efficiently and customer relationships are maintained.

Improving budgeting and forecasting

Reconciled data forms the bedrock of better budgeting and forecasting. Actual cash flow patterns and variances against budgeted figures can reveal forecasting inaccuracies. By comparing predictions with reality, companies can refine their models and increase the accuracy of future financial planning. Regular reconciliation enables agile budget adjustments in response to real-time changes. Historical and current data provides a concrete basis for projections.

Identifying inefficiencies (slow check clearing, high bank fees, etc.)

The reconciliation process can reveal hidden inefficiencies. For example, regularly noting extended clearing times for checks might indicate an opportunity to encourage electronic payments or renegotiate banking terms. High or unexpected bank fees that appear repeatedly may prompt a review of banking arrangements. Such findings can drive operational improvements and cost-cutting initiatives. Regular and comprehensive data analysis prevents minor issues from turning into significant losses.

Using insights from reconciled data to optimize financial processes

Beyond issue detection, reconciled data can drive process improvements. By analysing trends and anomalies, companies can identify areas to automate manual processes, refine reporting practices, and potentially strengthen internal financial controls. Recurring discrepancies could point to employee training gaps, or system errors that need correction. By examining reconciliation outputs strategically, companies can fine-tune their operations, leading to greater efficiency and reduced risk.

Final thoughts

Regular bank reconciliation is vital for accurate financial records, error detection, fraud prevention, and tax compliance. Comparing internal records with bank statements provides a clear view of your cash position, aiding decision-making. 

Consistent reconciliation, ideally monthly, ensures accurate reporting, offers operational insights, and acts as a powerful management tool. Neglecting it can lead to reporting errors, overpaid taxes, and increased fraud risk, negatively impacting financial health and compliance.

FAQs

Here are some common questions business owners have regarding bank reconciliation: