Bank
Reconciliation: Your Most Important Navigational Tool
The bank
reconciliation is defined as a process by which to compare a business
entity's book cash balance with the bank's cash balance as of a given
period so as to note any discrepancies. What person would attempt to sail
across the ocean without a compass, map, and a sextant?
These
are traditional navigational tools without which one could easily lose
one’s way. In accounting, the bank reconciliation serves the same
navigational purpose. Here’s why:
Cash is
the lifeblood of a business organization. With it you succeed, without it
you fail. Cash is so vital to an organization that one must continually
keep track of its flow in and out of a business. This flow of cash is
analogous to the pulse beat of a human heart. Some businesses check this
pulse hourly, some daily. This is usually done via the running check
register balance. Deposits are added, checks are subtracted to find the
current cash balance.
Because
we know that life is not perfect, mistakes are made. In order to find
these mistakes, we need to have something from which to compare our
calculations. Since we deposit and withdraw our money from a bank we can
compare our records to theirs, hence a “bank reconciliation”. Once we have
done this we can be reasonably assured that our current check register
balance is correct. This is important, because we need accurate
information for planning purposes. For instance, can I afford to buy those
supplies? Will I have enough money to meet the payroll this week?
Admittedly, some people run their businesses by the “seat of their pants”.
I know individuals who call the bank everyday to find out what their cash
balance is. However, this method has a fatal flaw called “outstanding
checks”. You may have written checks that the bank hasn’t yet received.
What happens when those checks hit the bank? You had better have enough
deposits to cover them. This is not a good way to run a business.
The bank
reconciliation is the heart of your business bookkeeping. It brings light
where before there was darkness. It brings order where chaos could
potentially reign. Once completed, its power lies in the fact that you now
know exactly how much money was deposited in the bank and where that money
came from. In addition, there is no guessing as to exactly how much money
was withdrawn and for what purpose. It provides a document that you can
easily refer to for writing adjusting journal entries. This means you have
a clear-cut audit trail that shows where your cash activity originated and
how it arrived on the general ledger.
Once you
have reached this point in the process of preparing your financial
statements you are pointed towards home and the remaining items are
usually routine. Those who have tried to prepare financial statements
without the bank reconciliation as a guide understand and appreciate what
I am talking about.
When I
work on a set of books for a client, the first thing I do is the bank
reconciliation. You should do the same. Once you experience how everything
falls in place when navigating with this powerful tool, you will never go
back to the old way.
John W. Day, MBA is the author of two courses in accounting basics: Real
Life Accounting for Non-Accountants (20-hr online) and The HEART of
Accounting (4-hr PDF). Visit his website to download for FREE his 3
e-books pertaining to small business accounting and his monthly newsletter
on accounting issues. Ask John questions directly on his Accounting for
Non-Accountants blog . John Day may be contacted at
http://www.reallifeaccounting.com
jday@reallifeaccounting.com
