The Basics of a Bank Reconciliation Statement
I can remember my first auditing days and being asked to review the Bank Reconciliation Statement. The audit manager explaining that the Bank Reconciliation Statement was a key control from a Corporate Governance perspective.
For those of you who don’t have a Finance or Auditing background, what is a Bank Reconciliation Statement? Here’s a basic description:
- The Bank Reconciliation Statement takes the Cash Book balance per the General Ledger (GL) at a specific date (normally month-end) and tries to make it agree with the Bank Statement. In an ideal world the two numbers will agree – job done! But, more often than not, the two balances will not agree and there will be bank reconciliation problems – these will usually be just “timing differences.”
Bank Reconciliation examples & timing differences
Bank Reconciliation examples or common timing differences include:
- Cheque payments to suppliers that have been posted to the GL but have not yet been presented/cleared by the bank.
- Bank charges or interest that has already been debited from the Corporate’s bank account but has not yet been accounted for in the GL.
- Cash receipts that have been collected by the bank but not yet accounted for.
These bank reconciliation examples of “timing differences” are customary and typical in the normal course of business. By undertaking the bank reconciliation statement on a regular basis (usually monthly), it allows Corporates to ensure that all transactions are correctly accounted for and identify fraudulent activity – hence being labelled a key control.
Undertaking the reconciliation process a number of days after the month-end allows timing differences to unwind and therefore simplifies the Bank Reconciliation process. They usually unwind after a few days as supplier cheque payments are presented and cleared by suppliers at their respective banks. Sometimes these timing differences can become permanent if suppliers forget to present cheques (it does happen!).
Read The Hackett Group paper: Why Treasurers should care about bank APIs
Key consequences of the current reconciliation process
A couple of key consequences of this reconciliation process are:
- A Bank Statement Reconciliation which includes entries that fail to unwind from one month to the next is an indication that financial processes are not optimized.
- As a Corporate accounts for receipts in its Cash Book, the accounting entries result in “open items” in the Accounts Receivable (AR) ledger to close – thus confirming that a customer has paid for the services or goods received.
- Items that can’t be reconciled may be evidence of fraud – an out-going payment that has been processed out of the bank account but there is no accounting entry in the cash book.
Bank Reconciliation Statement issues
There are several bank reconciliation statement issues:
- The Bank Statement Reconciliation has traditionally been performed based on the prior day closing position. As mentioned earlier, it is often easier to reconcile a month-end close after a few days as the timing differences may have had time to unwind. So, in reality, the Bank Reconciliation Statement may only be completed several days after the month end.
- It is a hugely manual process. Generally, the reconciliation will be performed by a finance assistant, but the month-end reconciliation will also need to be printed and signed-off by the finance manager for Sox compliance purposes.
- For certain industries such as shipping or distribution, goods may only be able to be released to clients once payment for the stock has been received or the credit department has confirmed that the client is operating within agreed credit limits. These process controls require real time visibility of receipts, which, for corporates operating in “legacy world”, necessitate regular accessing of bank portals or waiting for scheduled MT942 messages.
- In treasury, it may be necessary to check that payments/receipts have been made/received on a same day basis – examples include settlement of FX transactions, money market deposits, margin calls on commodity hedges. Performing the bank reconciliation daily will ensure transactions have been processed by the bank and that late payment penalties are avoided. As a result, it will be common practice to undertake a daily Bank Reconciliation Statement.
Attempting to automate the bank reconciliation process
These Bank Reconciliation Statement issues and the manual nature of the control have resulted in attempts to automate the process using technology. Treasury Management Systems (TMS) and ERPs have functionality to assist in the reconciliation process. Electronic bank statement formats, such as BAI, provide standard codes for standard transaction types allowing the TMS or ERP to automate the accounting/posting to the Cash Book from the Bank Statement.
Electronic Bank Statements using XML provide significantly more remittance advice detail. As a result, it has become much easier to clear open items from the AR ledger, where this data may have been truncated in MT format bank statement messages.
These processing improvements have led to Shared Service Centers (SSC) reporting a Straight Through Processing (STP) or Straight Through Reconciliation (STR) rate as a departmental KPI. The higher the percentage, the greater the number of transactions that are automatically posted to the GL. It is not uncommon for corporates to have STR rates of around 50% – meaning that 50% of transactions will need manual intervention resulting in a huge burden on already stretched Finance departments or SSCs. At the other end of the spectrum, an STR rate of 95%+ would indicate an extremely high level of automation.
To achieve these extremely high STR rates, new technology solutions have become available. Often, they include Optical Character Recognition (OCR) tools, the ability to access 3rd party websites, access email folders and Excel files in order to identify 3rd party remittance advices. They increasingly also include AI technology allowing the system to progressively learn how to automatically reconcile items which initially require manual intervention.
One constraint of these tools is that they require bank statements and open AR items to be downloaded into a third-party system in order for it to perform its reconciliation process. Reconciled items then need to be loaded back into the ERP and accounting entries passed. If this process is not undertaken daily, it implies that the reconciliation is not fully up to date.
Read The Hackett Group paper: Why Treasurers should care about bank APIs
How bank APIs are changing the reconciliation game
The latest reconciliation tools use APIs to get bank balances and transactions in real-time. This allows for the reconciliation to happen in real-time. There are several benefits of this process:
- AR teams can focus at an earlier stage on the remaining unreconciled/disputed items
- The Bank Reconciliation Statement is now based on current day closing balance rather than yesterday’s closing balance. This significantly accelerates the month-end closing process and can ultimately lead to a one-day improvement in DSO – another key KPI often reported by Corporates to the financial markets to demonstrate processing efficiency.
So, Bank Reconciliations have actually come a long way with many bank accounts being reconciled daily and tools using AI increasing STR rates to above 95%. Bank APIs are further improving the process by allowing the reconciliation to be undertaken on the current bank balance rather than the prior day closing balance.
Improving your bank reconciliation process by knowing what to ask
How can you support your Finance and SSC teams? – by asking probing questions! What is the STR rate? Is this consistent across geographies? How many people are employed in AR teams? What technology is used? What items are failing to reconcile automatically – could customers be asked to pay using a different instrument (e.g., electronic vs cheque)? Would APIs allow for stock to be released to customers without laborious checking of banking portals or ringing banks to get confirmation of receipt of payment?
Bank Reconciliation Statements is certainly an area when significant processing efficiencies can be achieved freeing up resource for more added value activities. As technology solutions become more affordable, it is increasingly simple to demonstrate a favorable ROI.