What is account reconciliation in finance?

Prophix ImageProphix Feb 7, 2024, 5:00:00 AM

Account reconciliation can be a daunting task for financial teams of all sizes, but the benefits make it indispensable when it comes to managing your business accounts. This article will cover the basics of account reconciliation, the benefits it provides, what the process requires, and how to do it as efficiently as possible.

What is account reconciliation in finance?

Account reconciliation is the process of ensuring your company’s General Ledger (GL) is correct and balanced by comparing it against secondary sources. It provides assurance to finance and accounting teams that their books are complete and up to date during the close process. Reconciliation also provides confidence in any GL data that is used in reporting and decision-making. Best practice is to reconcile all GL accounts monthly—a significantly labor-intensive task which automation can expedite—allowing you and your teams to stay up-to-date faster.

Why is account reconciliation necessary?

The accuracy and integrity of the GL are essential to multiple aspects of your organization. Beyond its importance for reporting and decision-making, there are several key benefits of reconciliation:

  1. Identify and resolve errors and discrepancies faster
    Issues can’t be fixed until they are identified. Best practice is to reconcile accounts each month, providing the opportunity to find and resolve accounting errors sooner, identify unauthorized activity, and ensure that company funds are going where they are needed.
  2. Track payments, fees, and spending
    Regular payments can be tracked more efficiently, ensuring they reach vendors on time and avoid costly service interruptions. Fees and spending can be monitored more effectively, avoiding any cases of banking or tax issues in your balance sheets.
  3. Provide accurate and up-to-date financial reports
    Internally, key decisions are made using financial data, and the availability and accuracy of that data is fundamental to these decisions.
    Externally, audits and accountability also depend on these reports. Being able to quickly provide up-to-date information can speed up these processes.
  4. Manage and streamline company cash flow
    Not only does reconciliation keep your team hands-on and in touch with your finances, but it also provides an opportunity to identify and fix inefficiencies.
Why is account reconciliation important?

What are the different types of account reconciliations?

While the account reconciliation process is similar across accounts, there are some key differences to keep in mind.

  • Bank reconciliation
    • Bank reconciliation is the most common form of reconciliation. Bank reconciliation is done by taking your bank statements and your business accounts and making sure they agree.
  • Petty cash reconciliation
    • Because it’s easy to lose track of petty cash, this kind of reconciliation verifies that these cash accounts agree with company policy and receipts, an essential process to avoid errors and misuse.
  • Vendor reconciliation
    • Vendor reconciliation is the accounts-payable process of ensuring your actual expenses agree with the vendor invoices you’ve received.
  • Business-specific reconciliation
    • Business-specific reconciliation is the comparison of your internal records at the start and the end of your finance cycle. The frequency of this process depends on the type of business conducted, goods sold, or services provided. Financial services are often required to reconcile client accounts with client funds more frequently than other kinds of businesses.
  • Intercompany reconciliation
    • Intercompany reconciliation is the verification and balancing of transactions between companies and subsidiaries in the same corporate group.
  • Credit card reconciliation
    • Credit card reconciliation is the comparison of credit card statements against the companies’ records.

How account reconciliation works

Any transaction or movement of funds in a company is documented. When you have two sources for these transactions, there is room for discrepancies. Account reconciliation can be done anywhere you have a secondary source for your financial information, like a receipt, a bank statement, and similar documents. When compared, both sources should agree with each other. Reconciliation is the process of verifying that these entries agree and investigating any mismatched entries or outliers to fix the discrepancy and balance both sources.

Method 1: Reconcile to a financial statement, bank statement, credit card statement, or loan statement

The example below is for a credit card reconciliation, but the steps remain similar for a financial statement, bank statement, or loan statement. It is essential that other than interest and fees, there are no un-reconciled items in the statements.

  1. Collect and sort receipts and expense reports. This was traditionally done manually with paper receipts and expense forms but can now be automated using expense management software.
  2. Match transactions to the statements. Every recorded transaction in the credit card statement should have its matching receipt or expense report with agreeing values.
  3. Resolve errors. Not all errors are intentional or malicious, sometimes mistakes happen. For example, on a credit card, there may be a refund that was applied for a canceled transaction, a fee for a failed charge, or accidental duplicate charges. If any discrepancies are identified through this process, make sure to notify your bank.

Method 2: Reconcile to account activity

  1. Compare the bank statement of the account against the cash statement. Make sure all entries are in agreement across both sources and note any entries that have no counterpart.
  2. Identify payments on one side that will not appear as payments on the other. These can include checks and ATM transactions on the cash book side, and service charges, overdrafts, and fees on the account side.
  3. Match transactions that appear in both records. If there are any that do not have an appropriate entry in the other record, add it.
  4. Check the bank account statement for errors. Bank errors are rare, but it is essential to notify your bank as soon as any are identified. The correction will then appear in future statements but will need to be balanced now to complete this cycle’s reconciliation.
  5. Verify balances agree. Once all the outliers and errors have been resolved and balanced, both statements should now agree. Any discrepancies should be reported and explained.

Method 3: Reconcile to subledger activity

  1. Like the previous methods, start by comparing GL entries against the subledger and identify any discrepancies. Pay close attention to any non-recurring transactions, since these are the most likely entries to have errors. Other common issues are duplication errors, entries in the wrong account, and transposition errors.
  2. Match entries across ledgers. Make sure each entry has its counterpart in the other ledger, and that the amounts agree. Note any errors.
  3. Investigate errors. Once the errors are identified and understood, take the appropriate steps to resolve them and ensure they are correctly entered on both ledgers.
  4. Compare and adjust balances. If all the adjustments and corrections have been completed, the ledgers should now agree.

What about reconciling with a roll-forward?

Unlike a full reconciliation, a roll-forward does not use a second source of information to validate activity. This method results in low error detection rates and low internal control and is not recommended.

How often should a business reconcile its accounts?

The best practice is to reconcile your company's accounts at least once a month. This aligns with bank statements which helps to simplify and organize the process. Monthly reconciliation provides financial agility and flexibility to identify and resolve errors.

For businesses with irregular financial cycles, with seasonal spikes, or where responsibilities and workload fall more heavily at certain points of the month, it may be best to defer reconciliation to accommodate these irregular workloads.

Businesses with a higher volume of transactions or risk of fraud may do daily reconciliations. This has the advantage of identifying issues before funds move from your accounts. If that seems excessive, keep in mind that this is not ideal for every business, and most companies that do daily reconciliations have a dedicated team for that purpose.

Account reconciliation and single-entry bookkeeping

Businesses that use single-entry books can still reconcile their accounts. Your GL should still agree with secondary sources like your bank statements. For a single-entry GL, you may add a column to your ledger that you can use to indicate that the entry has been reconciled with its second source.

Financial consolidation and account reconciliation

When dealing with multiple companies or subsidiaries, an inefficient intercompany reconciliation in the financial consolidation process can dramatically slow your close. It can be a painful and time-consuming exercise to get to the bottom of discrepancies.

Generally accepted best practices are to decentralize reconciliation by putting the responsibility on the subsidiary and to anticipate your close at the start of the cycle to prepare processes ahead of time.

Another issue with intercompany reconciliation is the tools used to perform the reconciliation and consolidation. Contrary to what you might expect from decentralizing, a single comprehensive tool offers far more reliable reporting and rapid closing than separate tools.

Steps in the account reconciliation process

Across all types of account reconciliations, there are consistent steps you will always need to take. It doesn’t matter if it’s a credit card reconciliation with a single-entry ledger for a small business or an intercompany reconciliation.

1. Determine the starting point

The first step to starting the reconciliation process is to, well, start! Your team should identify the accounts that need to be reconciled, gather the beginning balances for your chosen reconciliation period, and ensure they’ll have access to the supporting documentation they’ll need.

2. Gather your data

At this stage, your team needs to go on a fact-finding mission. Like a lawyer building their case, they should collect all relevant financial documents, compile all supporting documentation for recorded transactions, and double-check the accuracy of what they’ve gathered.

3. Analyze the data

This is the longest, toughest step of account reconciliation: actually analyzing everything that’s been put together. The exact method used in this step will vary on your industry and your team’s specific approach, but generally you’ll go through every transaction and match it up with supporting documents.

4. Save your documents

After your analysis, you need to ensure you have a systematic way to record your findings and make them available to the organization as a whole. If such a filing system isn’t already in place, make sure to set one up.

Causes of account reconciliation discrepancies

The discrepancies you’ll find during a reconciliation can broadly be grouped into four categories: human error and mistakes, timing differences, missing or incomplete data, or fraud.

Human error and mistakes

Human error can’t be completely eliminated from any finance process, and that includes reconciliation. Here are some common errors to watch out for:

  • Business-side errors: Mistakes in recording transactions, such as omissions or wrong entries in the cash book, contribute to differences between balances. This can sometimes be attributed to using manual systems, like spreadsheets, to record transactions versus dedicated software.
  • Bank-side errors: Though rare, errors made by the bank in recording transactions, like omissions or inaccuracies, are not impossible and can lead to disparities between book balances.

Timing differences

Timing differences can impact both check-based transactions and automated deposits:

  • Cheques: Because of the potential delays when dealing with cheques, they are a frequent cause of reconciliation issues. Any cheques that have been issued by bank but not yet deposited, or paid into bank and not yet collected, will result in discrepancies.
  • Automated debits, credits, and deposits: Any automated process that the bank handles on behalf of the business can cause the accounts to change without any note made on secondary sources. This includes direct debits and credits made by the bank on behalf of the customer, any payments the bank handles on your behalf like rent or utilities, direct deposits, interest, dishonored items, and dividends.

Missing or incomplete data and transactions

Not all departments operate with the same rigor, and your finance team may have to deal with missing data when reconciling accounts. Thankfully, these discrepancies are usually easy to spot; you simply won’t find a matching record for the transaction you’re trying to reconcile. Unfortunately, reconciling them can be tricky, and will usually involve getting in touch with the department responsible for the discrepancy.

Fraud

Account reconciliation is an important part of fraud prevention since it allows the finance team to take a fine-tooth comb to every financial transaction. This kind of close observation will usually reveal the issue and allow you to investigate further.

Common challenges in account reconciliation

The hardest part of any reconciliation is resolving the discrepancies. It is often a time-consuming process to determine the root cause of the discrepancies.

If your organization has a high volume of transactions, that will only exacerbate the above issues. More data means more time, and more opportunities for errors. As discussed above, companies that have a prohibitively high volume of transactions may want to consider more frequent reconciliation, to reduce the scope of each process.

Manual processes are subject to human error. Those same human errors that cause discrepancies in the first place, like typos, oversights, and data entry mistakes, can all happen during the reconciliation process.

The quality and consistency of your source data matters. Different formats of your data sources can result in inconsistencies when trying to make them all agree with each other.

To address these challenges and more, a dedicated financial performance platform that handles reconciliation is ideal for automating and streamlining the process.

How to choose account reconciliation software to simplify the AR process

When choosing the right reconciliation software for you and your business, there are numerous questions to consider. Here are five to think about:

  1. Does the software integrate with your existing financial and ERP systems, accounting software? This will reduce data quality inconsistencies.
  2. Does this software have the automation features that you want? The end goal is to mitigate the chance for human error to affect your close, so the more robust the automation, the better.
  3. Will this software require significant onboarding or is it intuitive enough to streamline itself into your existing workflow? Sophisticated software does not have to have an indecipherable interface. Effective and familiar design along with comprehensive documentation and support will help your financial teams begin using the software sooner.
  4. How secure is the software? Does it have appropriate security measures like encryption and secure access control to protect your data?
  5. Will the software provide real time visibility into the processes it will be handling, and will it provide your financial teams with adequate tracking and monitoring tools? Does it also provide compliance and auditing capabilities?

Benefits of account reconciliation software

Account reconciliation software can completely change the way your team handles this essential financial process. Here’s why.

  1. Automation and efficiency: By automating the laborious task of reconciliation, and speeding up identifying discrepancies, account reconciliation software allows your finance team to spend their time in the resolution of those discrepancies.
  2. Error reduction and data accuracy: Account reconciliation software is designed to minimize the risk of human errors associated with manual data entry and matching. The accurate matching of transactions reduces the odds of discrepancies.
  3. Visibility and compliance: Reconciliation software provides real-time visibility into the reconciliation process, allowing you to track the status of reconciliations, view historical data, and trivialize reporting. This visibility is crucial for compliance purposes, as it creates a clear audit trail, ensuring transparency.

    Ideally, the software will feature support for regulatory requirements and facilitate smoother audits by said regulatory bodies.

Benefits of account reconciliation software

Conclusion: Easier account reconciliation with finance technology

The right technology can simplify your close processes with comprehensive automation, streamlined transaction matching and minimized manual effort. The right financial performance platform makes reconciliation easier and more efficient. Learn more about choosing the right financial performance platform for you.

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Prophix

Ambitious finance leaders use Prophix to drive progress. By improving the speed and accuracy of decision making, Prophix’s Financial Performance Platform elevates the talents of finance teams to do their best work. Crush complexity, reduce uncertainty, and illuminate insights with access to best-in-class AI insights and planning, budgeting, forecasting, reporting, and consolidation functionalities. Prophix is a private company, backed by Hg Capital, a leading investor in software and services businesses. More than 2,500 active customers across the globe rely on Prophix to achieve organizational success.

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