Reconciling your company’s balance sheet is one of the key elements to “closing the books” at the end of an accounting period.
The accuracy of a company’s balance sheet ensures the accounting department and business owner have a clear view of the company’s financial position.
Plus, outside advisors such as bankers are able to evaluate the creditworthiness of your business based on the health and accuracy of its balance sheet.
Monthly balance sheet reconciliation is important for any business, but can present challenges to small business owners and their accountants.
Upon closing each accounting period, each account on the balance sheet needs to be reconciled to be closed; this ensures accuracy of the data. Among the most important accounts that need to be reconciled typically are:
- accounts receivable
- prepaid expenses
- accounts payable
- payroll liabilities
- accrued liabilities
- loans and other debt
What is a balance sheet reconciliation?
Properly reconciling a balance sheet account is making sure you have recorded and accounted for every transaction in your business–and applied the proper classification in the process.
Your balance sheet lists Assets and Liabilities as well as Owner’s Equity.
Assets are items such as cash, receivables, inventory, prepaid expenses and fixed assets.
Liabilities include amounts owed to vendors, customers, employees, debtors and others. Accounts that include liabilities are typically accounts payable, payroll and taxes payable, notes payable, deferred revenue, and customer deposits. It is important to understand these categories.
Your business may have gray areas, so it’s important to turn to a qualified accountant or outside firm to determine the most appropriate categorization.
Miscoding or misallocations are common errors and often at the root of many small business owners’ frustrations in managing their business based on accurate financial information.
An accountant that has experience across a range of industries, with a solid understanding of GAAP accounting practices, can prevent future issues that make monthly balance sheet reconciliations time-consuming for small and medium-sized companies.
Keep in mind, not all accounts are created equal. Reconciliation itself can mean a couple of things. For your situation, it may mean “to agree the balance on monthly financial reports in a supporting system.” You may have supporting systems such as those in your warehouse management software, in Excel spreadsheets, or in your accounting software itself.
In other cases, reconciliation may mean, providing “a list of transactions making up the balance and ensuring all transactions are properly classified.” A qualified accountant should be able to provide guidance and advise you on the right balance of accuracy and time.
Reconciliation of Cash
The bank balance should match what is currently in your accounting software with the difference of uncleared checks and deposits in transit. If the two do not tie, you cannot move forward with reconciling the balance sheet.
Identifying the discrepancy can be time consuming, which is why business owners rely on their accountants or consultants to make sure everything that cleared the bank is recorded in the financial software. Additionally, any uncleared transactions more than 45 days old require you to provide an explanation as to why it has not yet cleared the bank.
Reconciliation of Accounts Receivable
This account is very important and determines how much money you should be collecting from your customers and when.
Ensure that the data in this account is accurate. Find out if there are any invoices that need to be written off or need to be followed up with. Any item in this account that has aged over 90 days past due needs to have an explanation as to why it has not been paid.
If you find that you are writing off unpaid invoices more than you think seems reasonable (as a percentage of total billings or invoicing), you may want to re-assess how you manage invoicing and collections.
Look at your average day’s sales outstanding regularly, and if there are simple and friendly collection methods your own people can do by phone, mail or email, put into place more regular outreaches to customers to break any adverse patterns, if receivables aged over 60-90 days are more than a small percentage of revenue.
As an added bonus, the extra attention paid to the accounts receivable account will often bring an influx of cash into the business.
Reconciliation of Inventory
At the end of a predetermined time period (typically quarterly or annually), an inventory count should be performed. The physical inventory on hand must match the book balance. If there is discrepancy between the two, an inventory adjustment in your financial software will be required.
Further, identify the root cause of the discrepancy. You may uncover theft, fraud or abuse through this process. Other shortages could be make-goods done in a hurry to please a customer, and while performed with every good intention, employees need to be apprised of the impacts of failing to note when they take even the smallest items out of inventory.
Reconciliation of Prepaid Expenses
This is an asset account. It is used to defer the recognition of the expenses previously paid until the services or goods have been used. The procedure to reconciling this account is assuring that all the closing journal entries were made and the balance at month end matches the prepaid expense schedule used to calculate the monthly expense.
Reconciliation of Fixed Assets
For many service businesses reconciling fixed assets quarterly or even annually is reasonable. For others with a large number of fixed assets, monthly reconciliations are necessary.
The main goal here is to provide a check and balance that the business still has the machinery, computers, autos, etc that it thinks it does. If there are discrepancies, there may be issues with theft or poor reporting and the company may need greater cash on hand for replacements and may be overpaying taxes.
In addition to a check and balance on the fixed assets owned by the company, a regular fixed asset reconciliation ensures that the company is able to account for and record the proper depreciation expense on the income statement.
Reconciliation of Accounts Payable
Just as important as reconciling cash is reconciling the accounts payable account. This account is responsible for tracking what your company owes to its vendors for products and services and typically makes up most of your company’s current liabilities.
Ideally, this account is kept up to date on a weekly basis as most companies prepare a weekly check run to pay their vendors. Without correctly knowing what is owed to vendors, the business may underpay their vendors potentially impacting the vendor relationship. Or the business may overpay vendors which could create an internal cash problem.
Typically, a lower level accounting person is responsible for entering vendor invoices in the accounting software but the reconciliation should be handled by a more senior level accountant to ensure invoices are not duplicated and erroneous invoices are not entered.
Similar to accounts receivable, any amounts outstanding over 60 days should have an explanation as most vendors require payment within 30-60 days of when the invoice was created.
Reconciliation of Payroll Liabilities
Almost all companies have employees that are paid either on an hourly basis or earn a salary. Payroll cycles often overlap between months and actual payroll payments typically occur days or a week after the payroll cycle ends.
When the payroll transaction is processed through the accounting software the same date the payroll is extracted from the bank, there is a chance that some of the payroll may not be recorded in the correct period.
This creates a problem for business owners as they try to compare labor costs month over month or as a percentage of revenue, because they will not have accurate financial data.
The payroll amounts that should be accrued for are the hours/days that employees worked within the month but have yet to be paid for. This doesn’t just relate to wages, but also to payroll taxes (state & federal), retirement accounts, vacation/PTO, bonuses, and commissions.
There are a few different acceptable accounting practices to recording payroll liabilities at month’s end, but the important part is that when a practice is adopted that practice does not change.
Reconciliation of Accrued Liabilities
This account is exactly the opposite of the Prepaid Expense account. This account holds a balance that is owed for services and goods you have used, but not yet received and invoice or paid for. Reconciling this account is fairly similar to the Prepaid Expense account: match the book balance to the balance on the schedule used to calculate the monthly adjustment to this account.
Reconciliation of Loans
Reconciliation of amounts owed to people, businesses, banks or other creditors must be done on a regular basis.
It is extremely important that all loans or amounts owed by the business are listed as liabilities on the balance sheet. Otherwise, your financial statements are incorrect and you will be misrepresenting your financial position.
Reconciliation of loans, notes payable, a line of credit relies on matching the source documents to the amounts shown on the balance sheet. It is also a best practice to include a note or supporting schedule that summarizes the amount of principal owed, the term and end date, the interest rate and any other specific relating to each loan.
Finally, each month your accountant should review the detailed schedule to determine the amount that should be included in current liabilities (to be paid within 12 months) and long term liabilities. This is important as it will affect your key financial ratios and inform management decisions.
Performing a monthly balance sheet reconciliation is crucial to understanding and evaluating the financial position of your business.
We have covered just a few of the key account reconciliations. But regular reconciliations should be performed on all your balance sheet accounts—and doing monthly balance sheet reconciliations will keep you up to date while reducing time spent over your fiscal year, if reconciliations are put off or done intermittently.
Click here more information on monitoring balance sheet and income statements.