Account reconciliation is an essential step in the financial close process. It involves comparing financial records against one another to ensure there are no inconsistencies or errors across datasets.
A company’s finances must be accurate and easily accessible to run efficiently. Otherwise, executives cannot effectively determine if they are earning a profit or loss. They also won’t know which suppliers they’ve paid and how much and the inaccurate and disorganized records can damage your business.
Reconciling your accounts allows you to discover erroneous charges or financial irregularities on multiple bank accounts. Regardless of company size, teams must regularly reconcile accounts.
However, the process can be tough.
So we’ll tell you what it means to reconcile your accounts, the main types of account reconciliation, and the efficient way to do it.
What Is Account Reconciliation?
Account reconciliation compares third-party and independent financial statements and records with internal financial records and ledgers. Think of it as checking your work in algebra class.
Accountants perform account reconciliations to ensure that documents from all relevant sources are correct and complete.
For example, you can determine the accuracy of your balance sheet through account reconciliation because you are checking the balance sheet against the bank’s records.
If the records don’t match, finance experts can investigate to find the reason and make changes where necessary. Discrepancies can occur either intentionally or unintentionally.
Examples of unintentional reasons for differences are missing invoices or unrecorded transactions. For intentional discrepancies, you might find fake checks or misuse of funds.
Perform account reconciliations regularly to ensure the account balances displayed within your specified time frame are accurate. Doing this helps you detect errors or fraud early — or even avoid them.
You can automate account reconciliations monthly, quarterly, or annually, depending on your business and the type of reconciliation you’re doing.
Types of Account Reconciliation
Account reconciliations come in various forms and can be for personal or professional use.
There are five primary types of account reconciliation, and they all help you keep your balances in order.:
- Bank reconciliation
- Vendor reconciliation
- Business-specific reconciliation
- Intercompany reconciliation
- Customer reconciliation
1) Bank reconciliation
Bank reconciliation is the most popular type of account reconciliation. It compares transactions recorded in your ledgers to the monthly bank statements.
Most transactions, including payments and earnings, are recorded by the bank. So, reconciling bank accounts can help spot discrepancies in checks issued or missing transactions.
Performing a bank reconciliation at the end of the month is valuable because the bank sends the company a statement summarizing the starting balance, transactions from the month, and the final cash balance.
Reconciling monthly transactions helps organizations discover problems promptly and resolve them faster.
2) Vendor Reconciliation
Here, you reconcile your accounts payable records with statements provided by vendors and suppliers to ensure that the amount you paid for a product or service matches the amount received by the vendor.
Unlike bank statements, vendors don’t always send in their reports, so you may need to request them.
When reconciling your accounts payable records, you compare the vendor’s statement to your ledger to determine if the charge matches the amount you paid.
Vendor reconciliation helps prevent conflict between a business and a vendor by determining if the customer’s and vendor’s accounts are in sync.
When all records show the same transactions, the relationship between you and your vendors is strengthened.
3) Business-specific Reconciliation
For business-specific reconciliation, you compare internal records at the start and end of a financial cycle to see if the goods sold or services provided match your internal records.
Each business’s need will dictate the specifics of this reconciliation.
For instance, financial organizations often need to produce frequent reconciliations of accounts with client-owned funds.
This is one of the more demanding business-specific reconciliations.
4) Intercompany Reconciliation
Parent companies use intercompany reconciliation to unify all the accounts and ledgers from their subsidiaries. An intercompany reconciliation looks for mismatches within and between any two subsidiaries.
These may have resulted from billing errors involving loans, deposits, and payment processing activities. You can then rectify any errors in the company’s financial statement.
This ensures your records accurately reflect the company’s financial status.
Most parent companies do this to confirm invoices or loan records are error-free. Another reason for intercompany reconciliation is to identify which assets belong to which subsidiary.
5) Customer Reconciliation
Businesses perform customer reconciliation by comparing invoices sent to their accounts receivable ledger records. This process is valuable for companies that offer credit terms and options to their customers.
Accountants in these companies can compare the amounts received to the amounts unpaid.
The customer reconciliation statement reveals mistakes or anomalies in customer accounting.
It is typically done at the end of the month, just before a business releases its monthly financial statements, as part of the month end close process.
Challenges With Account Reconciliation
Depending on the size of your business, reconciling accounts across your organization might present multiple challenges.
Many of these challenges revolve around technical expertise and the number of records to reconcile.
Slow Processes
For many businesses, reconciliation is tedious and time-consuming. Small and large companies often face significant delays in receiving detailed statements from vendors and banks.
Most banks use a specific file format. This means you’ll have to use various file formats and standardize the files before uploading them.
Doing this requires time, and big businesses with numerous transactions can quickly exhaust a financial team’s resources.
Consequently, employees have less time for other vital activities such as financial planning.
Human Errors
Companies with many employees and subsidiaries often struggle with consolidating large numbers of records.
Mistakes are more likely to occur if you’re transferring data manually between databases. And the more steps in the process, the more likely the records will have errors.
A study published by University of Hawaii professor Ray Panko found that 88% of manual Excel spreadsheets contain an average of 1% or more errors within formulas.
These errors can be omissions, logic-based, or mechanical.
You can see some of the errors we have found for our clients here: Top 7 BIG Errors Discovered by the Datarails Customer Success Team.
Each step of data processing, including downloading, uploading, checking for consistency in files, and record matching, has a chance of error.
For example, you could download or upload an outdated file or reconcile the wrong accounts.
This, in turn, can lead you to overestimate cash flow, which could drive up the cost of making corrections down the line.
Role Exploitation
Fraud identification is one core function of reconciliation.
This procedure must also be adequately monitored to ensure corrupt employees do not exploit it to conceal evidence of illegal activity within the organization.
For instance, an employee performing vendor reconciliation could deliberately exploit their role to delete a record.
Too Many Tools
A bloated tech stack may work for a smaller company, but as the company scales, unpredictable consequences emerge.
A large company often has an extensive database to match. Managing these records across several tools might cause anyone to miss a crucial detail. Unfortunately, most businesses face this challenge, regardless of their industry or size.
With FP&A tools like Datarails, you can unify your accounts and perform tasks associated with reconciling accounts for your enterprise.
How to Reconcile Accounts
While there are tools for account reconciliation that handle a large chunk of the work, you still need someone to compare the records.
You can do this in three steps.
Step 1: Gather All Relevant Records
Get all related records, invoices, and ledgers for each type of account reconciliation you want.
For each month, this includes:
- Purchases
- Payments
- Expenses
- Earnings
Find out where these are recorded and gather them together.
Step 2: Compare the Statements
Start comparing your statements to the external ones and note the records you don’t have. It might be helpful to compare your records to theirs side-by-side so you don’t miss anything.
For example, you can analyze each transaction listed in the financial statements to corresponding ones on the bank statement by crossing them out.
You can then take note of any transactions that do not appear in the financial report so you can address them later.
To make things simple:
- Begin by focusing on the debits to your accounts.
- Check if every transaction for outgoing funds is recorded in your internal ledger.
- Do the same for credits.
- Check that your independent or third-party invoices and statements match the ones in your accounts and note the discrepancies.
Step 3: Review the Discrepancies
If you haven’t already, find those missing records and repeat steps 1 and 2. If you still have discrepancies, it’s time to dig deeper.
Review and investigate each transaction with mismatches and speak with the department involved to determine why your records don’t match.
If you’ve done a thorough internal investigation and still can’t account for the errors, it’s time to confirm with the vendors and banks that there are no errors from their end.
Unfortunately, banks rarely make errors in their statements because they are electronic records. So, you must exhaust all review methods before going this way.
For Better Account Reconciliation, Consolidate Your Data With Datarails
When you have all your data in one place, comparing accounts and spotting errors is easier. An effective reconciliation tool is essential to avoid the challenges of reconciling accounts manually.
Datarails helps you build data integrity and visibility, allowing you to see details and descriptions of your financial records for account reconciliation.
Request a demo to see how we can help consolidate your data.
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