If you’re like many small business owners, you might be managing your cash flow off your online bank account balance. As long as there’s a positive balance, you might think you’re doing just fine. Besides, producing and selling the goods or services of your company means you don’t have time for mundane and boring chores like reconciling your bank account.
But that approach can lead to disaster. Ignoring this essential task can leave you open to fraud, unauthorized charges, overdrawn bank accounts, and even problems with the IRS if you can’t prove the numbers on your tax return are correct. So let’s take a look at what reconciliation is and why it’s so crucial for entrepreneurs.
What is Account Reconciliation?
Account reconciliation is a method for ensuring that the numbers in your financial statements are right. Investopedia defines account reconciliation as “an accounting process that compares two sets of records to check that figures are correct and in agreement.”
For a bank account, the two sets of records you’ll be comparing will be your monthly bank statement and your own records of the cash going in and out of your bank account. Before computers, this might have been a handwritten checkbook register. Today, you might be using a spreadsheet. Today, with so many options for cloud accounting software, it’s unbelievably simple to keep accurate records. But just because your accounting software automatically downloads transactions as they occur does not mean you can skip this essential task.
The output of a bank reconciliation is a listing of the transactions in your accounting records that have cleared the bank account and transactions that appear in one set of records but not the other one. Your accounting records might show deposits from customers that haven’t yet reached your bank account or checks that haven’t been cashed. Your bank account might show payments, monthly fees, or interest income that haven’t been recorded in your accounting records.
Other accounts that need regular reconciliation include inventory, fixed assets, and credit cards. For the first two, you’ll need to verify that you actually have what’s listed on your balance sheet. If your business carries an inventory, you want to make sure you’re correctly deducting the cost of items as they’re sold and that they’re not walking out the door. If you let employees — even trusted employees — use company credit cards, there’s a chance that someone will use a company card to buy something personal. Reconciling your credit card accounts can catch that immediately, before it gets out of hand.
Why is Account Reconciliation Important?
Reconciliation is essential for making sure your accounting records are correct. But that’s only a small part of what regular reconciliation accomplishes.
Monitor your cash flow.
According to a recent study by CB Insights, cash flow problems were the #2 reason for startup failure. But you can only keep tabs on your cash flow if you know what you have, and what payments and deposits are outstanding.
Make better business decisions.
If your business is losing money, you’ll make different strategic decisions than you would with a highly profitable business. Keeping your accounting records reconciled and up to date means you can make better decisions because you can trust your data. You won’t be flying blind.
Detect fraud.
Small businesses are more likely than larger companies to experience theft of cash in the forms of billing schemes, payment tampering, expense reimbursements, payroll fraud, and skimming. That’s according to the ACFE’s latest global study on fraud. While regular bank account reconciliation won’t catch every instance of fraud, it does make it more difficult to continue hiding embezzlement, and it puts potential fraudsters on alert.
Avoid bank overdrafts.
If you’re only monitoring your cash via your online bank account balance, it’s easy to overlook checks or other payments you made that haven’t yet cleared your bank account. Regular reconciliation puts you on notice about those outstanding payments so you’re not as likely to spend money that’s already spoken for.
Report your numbers accurately.
Outside investors, banks, and tax authorities are sticklers for accuracy. They want to know how much revenue you brought in and what your expenses were. But those numbers are hard to nail down if you haven’t verified that your accounting records are in sync with your bank.
Find mistakes.
Everyone makes mistakes with numbers. Digits get transposed. Payments get entered twice (or not at all). Checks get deposited in the wrong bank account. Even banks make mistakes sometimes. You won’t find any of those problems if you don’t regularly reconcile your bank account.
Prevent tax problems.
If you can’t prove to the IRS or state or local tax authorities that your numbers are right, they may assess taxes based on what they think is correct. Reconciling your bank account regularly is one of the best ways to verify that you’re reporting the correct numbers.
How Do You Reconcile Accounts?
The process for reconciling an account depends on the types of transactions that flow through it. Bank and credit card accounts are the main ones that small businesses reconcile regularly. Nearly every accounting software package includes a built-in module for reconciling bank and credit card accounts. This makes reconciliation a matter of ensuring the bank feeds are current. Checking off matching items, and accounting for the differences between the two sets of records.
A key to reconciling any account is making sure that both sets of records have a starting point where they agree. If it’s been a while since you’ve reconciled an account, you’ll have to go back in time until you find a point where the balances match (which may be when the account was opened).
Get Reconciled
Now that you know what reconciliation is and how important it is, you won’t give your CPA that deer-in-the-headlights stare when they ask you about it. You’ll proudly point to your nicely reconciled accounts and make their day. Most important of all, you’ll always know how your business is doing, and you’ll have the right information to ensure you’re on the path to success.
The information presented in this blog article is provided for informational purposes only. The information does not constitute legal, accounting, tax advice, or other professional services. We make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability of the information contained herein. Use the information at your own risk. We disclaim all liability for any actions taken or not taken based on the contents of this blog. The use or interpretation of this information is solely at your discretion. For full guidance, consult with qualified professionals in the relevant fields.
