Keeping a close eye on your finances is important, whether you’re running a business or just managing your personal expenses. One key way to do this is by reconciling your bank statements. Bank reconciliation is the process of comparing your own financial records with bank statements to ensure accuracy. While it may sound a bit technical, it’s actually a straightforward process that can help you manage your money well.
At Remitly, we know how important it is to have a good handle on your finances, especially when you’re sending money to loved ones back home. Just like we simplify the process of sending money home, we’d like to give you a simple guide that breaks down why and how to reconcile your bank statements.
What does it mean to reconcile your bank statements?
Let’s take a look at what bank reconciliation is and why it’s important for healthy financial management.
Definition and purpose of bank reconciliation
Bank reconciliation is comparing your internal financial records (your cash book) against the balance and transactions shown on your bank statement, then adjusting for any differences. A “bank reconciliation statement” lists items, such as outstanding checks or bank fees, that explain why the two balances differ.
Regularly reconciling your bank statements helps you identify discrepancies like missing deposits, unauthorized charges, or bank errors, helping you maintain the accuracy of your financial records.
Importance of reconciling statements
Failing to reconcile your accounts can result in missed errors, such as duplicate entries or uncleared checks. It can also leave you vulnerable to fraud or overdraft fees. Routine reconciliation (at least monthly) safeguards against unauthorized transactions and supports more reliable cash‑flow management.
Relying on unreconciled records can lead to:
Inaccurate financial reporting: When your numbers are incorrect, this can distort your understanding of your profitability, cash flow, and your overall financial position.
Uninformed decision-making: Inaccurate financial information can make you think you have more money than you actually do, leading to overspending or missed investment opportunities.
Financial instability: In the worst-case scenario, unreconciled accounts can lead to financial instability. If you’re not aware of your true financial situation, you may face unexpected cash shortages or even insolvency.
How reconciliation works
So, how does reconciliation actually work? Let’s break it down.
Bank reconciliation process explained
The core principle of bank reconciliation is straightforward: you compare the ending balance shown on your bank statement with the ending balance in your accounting records.
However, in practice, these two numbers may not perfectly match, even if the information is accurate. Several factors can cause discrepancies between the two balances, including:
- Outstanding checks: These are checks that you’ve written and sent out but that haven’t yet been cashed by the recipient. As a result, they’ve been recorded in your books as a deduction but haven’t yet cleared your bank account.
- Deposits in transit: These are deposits that you’ve made but that haven’t yet been credited to your account by the bank. For example, if you make a deposit late in the day, it might not show up on your bank statement until the next business day.
- Bank fees: Banks often charge fees for various services, such as monthly maintenance fees, transaction fees, or overdraft fees. You might not be aware of these fees until you receive your bank statement.
- Interest earned: If you have an interest-bearing account, the bank will periodically credit your account with interest. You might not have recorded this interest in your books until you see it on the bank statement.
- Errors: As mentioned earlier, errors can occur in both your records and the bank’s records.
Step-by-step guide to reconciling bank statements
- Gather documentation: Obtain the relevant bank statement and accounting records, like your cash book or accounting software.
- Check opening balances: Ensure your starting book balance matches the previous reconciliation.
- Compare deposits: Verify and reconcile deposits appearing in both the bank statement and accounting records.
- Compare withdrawals: Verify and reconcile withdrawals (e.g., checks, payments) appearing in both sources.
- Identify discrepancies: Identify any transactions present in only one of the records.
- Adjust records: Make necessary adjustments to the accounting records to account for outstanding checks, deposits in transit, bank fees, and interest earned.
- Compare ending balances: After adjustments, confirm that the ending balance in the accounting records matches the ending balance on the bank statement.
Tools and software for effective reconciliation
Fortunately, you don’t have to perform bank reconciliation manually—there are plenty of tools and software that can make the process faster and more accurate.
- Spreadsheets: For personal finances or very small businesses, spreadsheets like Microsoft Excel or Google Sheets can be used to track income and expenses and perform basic reconciliation.
- Accounting software: For businesses, accounting software like QuickBooks, Xero, or FreshBooks can automate much of the reconciliation process. These programs can often automatically import transactions from your bank account, match transactions with entries in your accounting records, and generate reconciliation reports.
- Online banking tools: Many banks offer online banking tools that can help you track your transactions and reconcile your accounts. These tools might include features like transaction downloads, account alerts, and reconciliation reports.
How reconciling bank statements supports financial health
Once you’re regularly reconciling your accounts, you’re in a stronger position for:
Making better financial decisions
Accurate records help you make financial moves with confidence:
- Budgeting: Create realistic budgets and track your spending effectively.
- Financial planning: Whether you’re planning for retirement, saving for a down payment on a house, or simply trying to manage your monthly expenses, accurate financial data keeps you on track.
- Business decision-making: For business owners, accurate financial records are vital for making informed decisions about pricing, inventory, investments, and other key aspects of the business.
Managing cash flow effectively
Reconciliation provides you with a clear picture of how much money you have coming in and going out. This allows you to:
- Track income and expenses: Monitor where your money is coming from and where it’s going.
- Identify trends: Analyzing your cash flow over time helps you identify trends and patterns that can inform future decisions.
- Avoid cash shortages: Having a clear understanding of your cash flow enables you to anticipate potential shortages and take steps to avoid them.
Avoiding unwanted bank fees
Bank fees can add up quickly and eat into your profits or savings. Reconciliation can help you avoid these fees by:
- Monitoring your balance: You’ll always know your current balance and can avoid overdrafts.
- Identifying errors: You’ll be more likely to catch errors that may otherwise have led to unwarranted fees.
- Understanding bank charges: You stay aware of the various fees your bank charges, so you can take steps to minimize them.
Best practices for bank reconciliation
To maximize the benefits of bank reconciliation, it’s important to follow some best practices:
Reconcile regularly
The ideal frequency of reconciliation depends on the volume of transactions and the complexity of your finances. For most individuals and small businesses, monthly reconciliation is sufficient. However, businesses with a high volume of transactions might need to reconcile more frequently, such as weekly or even daily.
Manage discrepancies promptly
When you find a discrepancy, don’t delay. Take the time to investigate the cause—this may involve reviewing your records, contacting your bank, or both—and then make the necessary adjustments to your records.
Tips for small business owners
- Use accounting software: If you’re not already using accounting software, consider investing in it. Software can automate many aspects of the reconciliation process, saving you time and reducing errors.
- Segregate duties: If possible, assign the responsibility for bank reconciliation to someone who is not involved in the day-to-day handling of cash or accounts payable/receivable. This helps to create a system of checks and balances that can deter fraud.
- Maintain comprehensive records: The more detailed and organized your records are, the easier and more efficient the reconciliation process will be.
FAQs
Why do we do reconciliation statements?
Reconciling bank statements is important for catching errors, preventing fraud, and ensuring your financial records match bank activity—which is also critical for tax compliance and budgeting.
How often should you reconcile your bank accounts?
It’s recommended to reconcile your accounts at least monthly. Daily or weekly checks are best for accounts with high transaction volumes so that any issues can be detected early.
What are the benefits of bank reconciliation?
When you reconcile your accounts, you’re essentially verifying each and every transaction to align your accounts with the bank’s records, eliminating discrepancies and ensuring that your records accurately reflect your financial activity. This helps you to:
- Budget effectively: Accurate records allow you to create realistic budgets and track your progress toward your financial goals.
- Forecast cash flow: By knowing exactly how much money you have coming in and going out, you can better predict future cash flow and avoid shortfalls.
- Make informed investments: Accurate financial records are the bedrock of sound investment decision-making.
What kind of errors can bank reconciliation help me catch?
Regular reconciliation helps identify a wide range of errors—both in your own records and in the bank’s records. Common mistakes include:
- Data entry errors: These are simple mistakes, such as typing in the wrong amount for a transaction.
- Omitted transactions: Missing entries either in your records or the bank’s records.
- Incorrect postings: A transaction might be posted to the wrong account.
How does reconciling my bank statements help prevent fraud?
Regular reconciliation enables you to detect fraudulent activities early, allowing you to report them to your bank and take steps to recover your funds. Fraudulent activities may include unauthorized withdrawals, forged checks, or unexpected online charges.