For many business owners the company’s cash balance is whatever number they see when they log into their bank account or open the mail to look at the monthly statement.  This may not always provide an accurate picture of the company’s cash true position.  For EVERY organization, virtually all transactions with outsiders are done with cash in some form or another, whether it is related to expense payments or collecting on sales.

 

While a company might have generated significant profits, or received large infusions of capital, that does not always translate to cash flow or having cash on hand.  When your employees need to get paid, you use cash, the same with vendors.  Having a build-up of other assets that are not cash does not fund the immediate operations of the business.  You cannot pay with accounts receivable, inventory, equipment, or even the equity in the business.  A firm cannot go bankrupt with an abundance of cash, but companies that go bankrupt do so because of a lack of cash.  Keep in mind, you can also have plenty of cash, but if you’re neglecting your suppliers, that only lasts for so long.

 

In order to make sure the financial statements have integrity, there needs to be an anchor point from which everything else can be based on.  That anchor point is usually the cash account.  Unless you’re operating out of a shoebox, all the funds transferred through the bank accounts provide objective third party proof of what has occurred within the company (these records are usually higher accurate).  The other benefit of using cash as an anchor is it touches on virtually every sale and expense at one point or another, in other words, every transaction outside the company.  To prove out the reliability of the cash account, it is necessary to confirm, or reconcile, what the bank reports and what is recorded with the company.

 

Bank Reconciliation Basics

 

A bank reconciliation is important since it bridges the difference between the bank’s records and what the company says it has on hand.  If you are surprised that there is a difference, don’t be, it’s normal, and I’ll explain why below.

 

The two most common variances between the records of the bank and a company (assuming no errors on either side) are for 1) deposits in transit and 2) the check float.  Deposits in transit are payments to the company that have been applied against an account, but have not been recognized by the bank.  If a company collects on an invoice via a credit card payment on November 30, the company marks this item as paid in the customer’s account (which shows as an increase to cash), but the funds do not appear from the merchant processor until December 1.  In this case,, the company traded the receivable from a customer to a receivable from the credit card processing company (in this case, for only 1 day).

 

The second major variance in performing a bank reconciliation (and more common) is the check float.  Essentially, this represents checks that have been written by the company (and automatically deducted from the cash account in the accounting software), but have not cleared the bank.  There are several reasons why checks may not have cleared the bank:

 

1. The vendor received the check but has not deposited it yet




2. The check is still in the mail




3. The check was lost in the mail




4. The check is still sitting at the company and has either a) not been mailed out, or b) is sitting in a drawer intentionally (I have many stories related to this)

For instance, a company might show $100,000 in their account on the bank statement.   However, if you just dropped $300,000 of checks in the mail you do not really have $100,000 in the bank.  It may be acceptable to put more checks in the mail than you currently have in your bank account if you are a) confident that you have incoming deposits that will arrive before the checks clear, and b) you’re confident on the timing of when the checks will clear.

 

While doing regular bank reconciliations may seem some basic and elementary, not all companies are always diligent about staying on top of these things.  Over time, mistakes can be made and the true financial picture gets distorted.

 

How to botch a bank reconciliation

 

For companies that have not done a bank reconciliation in a long time (or EVER!), there are a host of issues to overcome.  For starters, knowing how many checks are in circulation that could still clear the bank.  If a company uses a software program (like QuickBooks), there are features built in to assist with performing a bank reconciliation.  There is a flaw with these as it assumes the company is staying on top of its bank reconciliations.  If not, there are a lot of available transactions from other periods that can be selected to perform a bank reconciliation, even though they may have cleared the bank in another period.

 

I have witnessed someone cut corners on a bank reconciliation to force a number to tie out.  This was done by grabbing transactions from the wrong period (months where no bank reconciliation was performed), entering the wrong amounts for certain charges, and finally, just ignoring certain transactions altogether.

 

If you’re relying on your financial statements to tell you what your expenses are, or how much money is owed to various stakeholders, but expenses and loans have never been recorded, it will make it hard to understand current profitability as well as being able to forecast your business in the future.