THE 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 In addition, there is no guessing as to exactly how much money was withdrawn and for what purpose.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.

Posted in: accounting,Accounting Fundamentals