How to Know Your Bookkeeping is Right: An Introduction to Reconciliations
It's the 1st of the month. You sit down for your monthly budget meeting with yourself and open up your bookkeeping records. You input the information from your bank statements from the previous month and hope you got it all.
Or, you input the information from your bank statements and do one simple task to guarantee you got it all.
Which one sounds better to you?
When you're just starting out, it's a little easier to keep track of all your records. But what if you've fallen behind several months? Or what about when your business grows and there are a lot more transactions to keep track of?
At some point, your memory won't be a reliable check to make sure you've rounded up all of your business transactions. Luckily, there's a solution for this!
When you reconcile your accounts, you're essentially proving that you got it all!
What is a reconciliation?
That's a question that is almost a guaranteed indication of age. Reconciling used to be a common household practice in the good ol' checkbook days. It may have even been taught in school!
I wouldn't know because it definitely wasn't by the time millennials made it to high school. So if you grew up reconciling checkbooks, bear with me for a second! If you can believe it, some of us have had to go well out of our way to learn how to do this - if that's you, listen up:
Outside of a financial context, you probably know that reconciliation has to do with harmony, compatibility, and consistency. Reconciling between two people in an argument involves making peace between the two, yes?
Now apply this to finances - or, more specifically, your bank account.
On a bank statement, you have a beginning balance and an ending balance - showing how much money was in your account on the first day of the month versus the last day.
Your job is to RECONCILE these two figures - essentially, you're going to prove them out so we know they're right.
If you're still feeling a little uncertain, that's okay. If you know that we're working to prove how the beginning balance became the ending balance, the rest should start to make sense as we get further into this post.
Important note: At this point, you should be doing your business' bookkeeping outside of your bank statements. Your bank statements are not sufficient financial record keeping by themselves. You also must have a separate bank account for your business.
A Reconciliation Scenario
Instead of giving you a fact dump, I'm going to walk through the bookkeeping data entry and reconciliation process with a simple scenario. Let's call it, story time.
It's August 1st. You're ready to do the July books.
You already have an account with Wave or Quickbooks Online where you do your bookkeeping.
In this scenario, we assume that the July beginning balance (logically, the June ending balance) is correct because we've kept up with reconciling our bank account each month.
You input your business-related income.
You input your business-related expenses.
You go to reconcile. Your software already has the July beginning balance (because you did June's books already!). You tell it what your ending balance is according to the bank.
You tell your software to reconcile.
Here's what's happening:
Your software knows what you started with.
It adds up all the income/deposit items, which increases the balance.
It subtracts out all the expense/withdrawal items, which decreases the balance.
It calculated the final balance. You told it what the ending balance should be. Ideally, the numbers equal each other!
If your numbers match, then Wave knows that everything that happened in your bank account this month has been recorded.
If your numbers don't match...
then your records (or perhaps even your bank's records) are wrong. The most common sources of an irreconcilable account are:
You had a typo when you entered the ending balance into your software.
You missed a transaction during data entry.
You duplicated a transaction during data entry.
You had a typo when you entered an amount or date during data entry.
What if I set up my bank account to automatically download into my software?
Then your job just got EASIER. But you should still reconcile! There can be import glitches, or you could have accidentally made a change that affected your software's records for your bank balance.
If you think it won't happen to you, come talk to me. Just a week before writing this post, I made a stupid mistake in a client's books (at my day job) that resulted in 3 hours of clean-up just so I could get the accounts to reconcile. Even with automatic bank downloads. It happens.
If I'm just inputting transactions off the bank statements, how would I know when the bank messed up?
If you thought of this question on your own prior to getting to this section, kudos to you. It probably took me 6 months of bookkeeping to finally think of this.
If the whole point of reconciling your bank account is to compare your external records with the bank's, what happens when your external records are based entirely off of the bank's? Won't you just be recreating their errors?
The short answer is yes. Yes you will.
Better answer? In theory, the proper way to do your bookkeeping and reconciliations is to track your own finances based on source documents. Actual check stubs, paid invoices, receipts, etc. Then, when you reconciled your records with the bank's, you'd be able to see if the bank activity reflects your paper trail.
However, people don't manage money this way any more. Online businesses work online. So we don't tend to have physical paper trails.
You could keep meticulous records as you go. Every time you make a purchase, you record the transaction right as you checkout on the website. Every time you get a notification of an affiliate payout (as in paid, not earned), you record the income. Every email receipt for a subscription payment made, you record the expense.
But that's not very practical, and we're too lazy for that. So we just use our bank statements. Ideally, the practice of diving into your bank's records and doing your own bookkeeping and reconciliations on a monthly basis will help you to detect any funny business happening in your account.
Plus, every now and then, you'll find an instance where the bank had their own simple math errors, and that's always fun to call them out on.
What if my beginning balance isn't matching the bank statement?
If you've reconciled a previous month but your beginning balance this month isn't right, then you most likely made a change that affected your records after reconciling. Once you've reconciled your account, you should not be making any bank account-related adjustments to your bookkeeping prior to the reconciliation date (usually the last day of the previous month).
If you made this mistake, you'll want to go and find the change you made and correct the issue. Either the transaction didn't need to occur at all, or you need to change the date for after the reconciled date.
Confusing? It is. That's because there's a bunch of reasons why a change could have been made to a reconciled account. If you're facing this issue, shoot me an email at firstname.lastname@example.org and we'll see if we can sort it out!
And for more troubleshooting tips, be sure to check out this post!
"I still don't see why this is important..."
I get it, this just sounds like one extra thing you have to do each month. That's because it is.
But accountants have processes like these to ensure accuracy. That accuracy is why they get paid the big bucks.
When businesses get more complicated, reconciliation becomes so much more important. It offers a layer of security, and can be a way of narrowing down the solution to a problem.
For example, let's say something isn't looking right with your financial statements. You're not sure at what point your numbers got thrown off throughout the year, but you know that income is too low.
In one scenario, if you really want to find this number, you'll have to dig through months of bank statements and check every item.
But, let's say that you know you've reconciled your bank account every month, and the bank balance on your balance sheet matches your bank statement as of last month (meaning you haven't made any further changes that affected the bank account).
So now you know that the problem isn't related to you missing the transaction. The money has been recorded, but for some reason, it wasn't classified as income. The likely scenario is it was accidentally classified as owner investment or even as a refund in an expense account.
Reconciling your bank account is not a mandatory practice.
The IRS isn't going to bust down your door if you don't do it (but your accountant might). But reconciling your bank account is both a smart and safe practice.
And it's not complicated. If you're already doing your bookkeeping and recording transactions in some software, it's only going to take an additional 10 seconds to do (unless your numbers don't add up, which you'd probably rather know NOW than a year from now during tax season!).
If you're using a manual bookkeeping system (Excel, paper, etc.), it still isn't difficult. Just grab a calculator, and do the math yourself!
Starting balance + deposits - withdrawals = Ending balance.
Still not sure?
Feeling intimidated? Schedule a call with me so we can completely wipe out those fears and questions that are holding your business back from security.
Until next time!
- Katie Scott