November 1, 2020

Financial Reconciliation: Step by Step Process

Finance Leadership
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Financial reconciliation is a process that all businesses get to know very well. To ensure the accuracy of financial statements, businesses must perform financial reconciliation. This can be done manually, but the time consuming nature and intense attention to detail makes it well-suited for automation.

While each business performs financial reconciliation on their own schedule, most follow the same steps. Here, we will dive into everything you need to know about account reconciliation, from the definition to the steps to how automation can help. 

Definition: What is Financial Reconciliation? 

Financial reconciliation is the accounting process of comparing different sets of financial records to ensure they match. Most companies perform financial reconciliation on their general ledgers as it’s the all encompassing record. Reconciliation helps to make sure that the money leaving an account is actually the money being spent, and money entering an account is accurately reported. 

To ensure financial accuracy, accounting teams and/or software will look at internal statements versus external statements (like statements from banks or credit cards), to make sure that they are in alignment. One of the most important aspects of performing financial reconciliation in a timely manner is the ability to stop fraud or avoid errors quickly. 

It’s true that some records will have discrepancies because of timing differences. For example, if you have made a deposit, but it is not yet reflected in your bank statement because of lag time, then records may not match on the day you perform the reconciliation process. These explainable differences are okay. However, unexplainable differences must then be investigated and rectified, which are all part of the reconciliation process. 

Additionally, financial reconciliation relies on financial standards. The generally accepting accounting principles (GAAP) is a set of standards by which businesses compile financial statements. GAAP can only be upheld if records are right. Financial reconciliation plays a large role in making sure this is the case because it validates internal documentation from external sources, and vice versa. 

As one of the most important internal controls for a business’ financial health, financial reconciliations are mandated for public companies. As such, their financial close is only complete once the process has been performed. Since public companies have to behold promises to shareholders, the reconciliation process is also regulated. This means that the accuracy is even more important because mistakes can cause serious ramifications and increase compliance risk. 

Methods of Financial Reconciliation

There are two main methods by which companies perform financial reconciliation. Regardless of which method you use, reconciliations must be completed on all balance sheet accounts regularly. 

  • Documentation review: Documentation review is the most commonly used method. It’s also generally done with the help of automation software. Like the name implies, it means that you will complete a data collection technique to examine existing records. When the data is in hand, then the software system can reconcile the accounts by comparing the data sets. 
  • Analytics review: Although it’s a less common way to perform reconciliation, analytics review can be used to spot irregularities in accounts. It’s done by taking historical data and the estimated balances of what a business expects should exist in an account. After performing analytics, if the reality versus expectation is jarring, then it can be a sign of financial mistakes and/or fraud. 

With either methods, it’s vital to find the cause of discrepancies and update accounts to reflect the true balances. 

Understanding Account Reconciliation: Double-Entry

The generally accepted accounting principles recommend using double-entry accounting to make the reconciliation process more accurate. Double-entry accounting means that for every transaction recorded in the general ledger, there is a record in two places. The record gets marked in the income statement and balance sheet. 

One will receive a debit, and the other receives a credit. That way, they zero each other out. For example, if there’s a sale, the debit goes into the accounts receivable or accounts payable section of the balance sheet. On the income statement, there will be a credit with the matching amount listed as revenue. 

It serves as a check and balances, literally and figuratively. This way, it’s harder to make a mistake because you can always find the corresponding record that should match up. 

Reconciliation in Business Accounting

Some businesses perform account reconciliation daily, weekly or monthly. Most commonly businesses take care of reconciliation each month, after the books are closed for the month before. 

Businesses must make sure that their general ledger account is correct since it serves as the company’s books and is the basis for many financial decisions. As a business owner, one of the biggest challenges faced in financial reconciliation is both the timeliness of the process and the accuracy of data. This is where automation comes in to aid the process. Automation tools can pull together data from various sources in seconds and only notify your team when there’s an anomaly. 

This means that your finance department can spend time on high-level tasks rather than monotonous tasks like collecting the right data and checking it for errors. We’ll come back to this soon! 

Why Reconcile Your Accounts? Benefits & Purpose

Any process that helps a business know their financial health is correctly reflected is a worthwhile process. Account reconciliation aims to help avoid overdraft charges, fraud, or incorrect credit card transactions. 

Furthermore, account reconciliation helps your company manage its money well. Your balance sheet needs to be right, and it can be made so with account reconciliation. Also, for a public company, it’s not a choice to reconcile your accounts. You can face serious penalties by independent auditors if your books aren’t being maintained honestly. 

The benefits of account reconciliation are clear, namely:

  • Detect errors like double payments or missed payments 
  • Spot fraudulent transactions 
  • Keep track of incoming and outgoing funds 
  • Add bank fees to your books 
  • Ensure your books are accurate 

When you need to decide how to allocate funds or whether or not a new venture is feasible, your books need to be right in real-time. Account reconciliation will help you make better decisions on the fly as your business’ financial health will be well-managed. 

Reconciliation Process: Step by Step Guide

The reconciliation process can be performed in just minutes with the right software. Even with an automation tool, there will be the need for human involvement to match records that should be manually added into your accounting system. 

You can perform account reconciliation by completing these five steps:

  1. Compare: First, you’ll have to compile the data you’ll need, which will be your internal account and your bank statement. Consider looking at your register against your bank statement to ensure every deposit and payment is in-line with each other. If there’s anything on your bank statement that doesn’t match with your transactions, then mark it for further investigation.
  1. Check Outgoing Funds: Your bank statement needs to take account of checks, charges and ATM transactions that are methods of outgoing funds. Be sure to note such transactions on your bank statement to match to your internal records. There are some fees that can be easily overlooked, so be sure to consider any ATM service charges or overdrafts, for example. 
  1. Checking Incoming Funds: If you’ve deposited money into any account and the bank has yet to reflect these changes, update your statement balance. At the same time, check that any deposit in your bank is also showing up in your internal books. Keep in mind that you may have to add interest into your internal books if your bank is accumulating interest in your account. 
  1. Look for Bank Errors: While it is rare, bank errors can occur. If you find such an error, be sure to get in touch with your bank as soon as possible so that they can rectify any issues on their end. 
  1. Validate Records: Once your bank statement and internal records reflect the same balance, then your reconciliation is complete. If you had to make adjustments in the process to take care of discrepancies, it’s best to make note of the changes for audit trails. If you’re using an automation solution, this should be handled for you. 

Reconciliation Best Practices

When conducting your account reconciliation on a regular basis, keep in mind these best practices and concepts:

  • Activity accuracy: Your reconciliation process should be used to verify that transactions are correct. This means that for every type of activity, it’s recommended to have documentation saved to support it. Activities should be monitored and standardised through approval processes. Take an expense report as an example. You’ll want that every employee fills out the same necessary information and provides supporting evidence to show what each line item reflects. When you have a clear process outlined for your internal control, it’ll make the process flow seamlessly. 
  • Error correction: There’s no doubt that errors are bound to occur. It’s important to focus on the timeliness of their resolution, rather than getting caught up in the fact there’s been a mistake. As such, it’s beneficial to have a process established by which your team can rectify issues. This can be a checklist of potential places to investigate for how an issue may have arisen in the first place. It should then also outline the steps to fix it and the kind of documentation needed to show what has been done. 
  • Documentation: Since reconciliations are consistently performed, they should be standardised and consistent. One of the best ways to make sure this happens is to automate the process. In any case, you can have a clear outline of the process. This will involve what each step is, who is responsible for it, how much time it should take and what the error correction process should be. 

Manual Reconciliation to Automation

Like with any process, the introduction of automation solutions can make it more efficient. Automation has streamlined account reconciliation into an easily repeatable list of steps. Accounting teams once relied on Microsoft Excel spreadsheets to manually compare data. It’s easy to see how time consuming and inefficient that can be. 

The manual process of reconciliation is highly error prone because the huge emphasis on numbers can easily lead to keying errors. When you remove the need for a human to intervene on the low-level tasks of data sourcing and entry, you free up their time to focus on more important analytical considerations. 

With an automation tool, you can harness the power to pull data from various sources and compare the numbers in a matter of seconds. This means that you can reduce your operational costs, increase productivity, reduce audit risks, actively manage the risk of fraud and boost internal controls. Plus, errors are easy to see as the system can alert your team of anomalies. If all looks good, the process can move through to approval quickly. If there’s any issues, then your team will be flagged and can conduct investigation to fix the problem. 

Electronic reconciliation means that you will always have an up-to-date view of your business’ finances. From data validation to recording information, you can easily run reports and provide audit trails, if ever needed. 

Automation and Auditing: The Benefits

Reconciliation is a key part of the financial close process and is regulated. Automation software provides unparalleled benefits when it comes to audits. 

For starters, you can leverage standardised templates and run the process in the cloud. With a template, the system will know what information to roll forward, what formulas to use and what documents need to be attached for support. With all the data stored in a centralised and easily accessible, yet secure location, anyone who needs to take a look will have the access to do so. 

Furthermore, with an automation solution, you can clearly document and share the reconciliation process so that your team members know exactly what they are responsible for. It makes it easy to see where the process is at any given time so that employees know the current status and are less likely to miss deadlines. 

The Bottom Line 

Financial reconciliation is a key process in every business. By using an automation solution, you can maximise your team’s efficiency, promote accounting accuracy and rest assured with easy-to-run audit reports.

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