More specifically, matching internal numbers from an SME’s general ledger with external numbers from an appropriate third-party document verifies that they make sense. The general ledger is the master set of accounts that aggregates all transactions recorded for a business.2 SMEs often overlook reconciliations, but they can be essential for maintaining integrity of the SME’s financial statements and as a financial control for the owner.
Because account reconciliation, especially cash reconciliation, has so many benefits for all SME’s, reconciliation of financial statements is generally regarded as one of the most cost-effective business controls a firm can use. First, it keeps the accounting staff, well, accountable, reducing undetected errors. Further, by requiring regular periodic reconciliations, any errors or irregularities are more likely to be caught early on. Review and discussion of the reconciliations help create an atmosphere of open, above-board business processes, protecting the SME from potential legal issues.
Reconciliation of financial statements also facilitates better understanding of business operations. Accurate, up-to-date, reconciled financial records show the true state of operations, and therefore are a better basis for making business decisions. For example, cash reconciliation helps an SME owner better manage cash balances to prevent overspending, or overdrawing bank accounts.
Moreover, accurate, reconciled financial statements are necessary to secure outside debt and equity investments, which is important in light of the fact that nearly half of all small businesses apply for financing, according to a recent survey by the Federal Reserve Bank of New York.2 In the case of publicly held SMEs, the Sarbanes Oxley Act requires reconciliation of financial statements, as it is considered a best practice for internal controls.4
Finally, account reconciliation of balance sheet accounts examines the cash flows into and out of a business, ensuring that they are appropriate by corroborating with external records. For this reason, cash reconciliation is a primary control to prevent fraud. Reconciliations can uncover employees who create inaccurate journal entries or commit payroll fraud to pay themselves more money. Approximately 70 percent of check fraud occurs in businesses with fewer than 100 employees.5
General ledger account reconciliations primarily concentrate on an SME’s balance sheet accounts, specifically assets and liabilities.6 The reconciliations are best done at the account level, rather than in totality. That means, for example, that a business with multiple cash accounts will want to reconcile each one separately against its external data counterpart (e.g., a bank account statement). The strictest financial guidance proposes that every balance sheet account be reconciled as part of a firm’s monthly closing process, but given time and resource limitations, experts agree that the most important accounts that need to be reconciled are:
External data typically used for comparison include bank statements, merchant processing reports, inventory counts, supplier invoices, credit card statements, payroll reports, and loan statements. This process ensures that transactions are properly coded, valued and are valid, since adjustments to the general ledger account balance are made if balances do not match.
Cash reconciliations are generally regarded as the most crucial of the account reconciliations due to the catch-all nature of cash accounts. By reconciling cash accounts to bank statements, all day-to-day transactions paid by debit card, check or electronic fund transfer (EFT) are captured. Another reason cash reconciliation is considered a high priority is cash’s high propensity for theft. As such, some experts recommend weekly reconciliations rather than monthly, and most accounting software packages can facilitate daily cash reconciliations.
Cash-to-revenue reconciliation is one key exception to the focus on reconciling balance sheet accounts. Cash-to-revenue reconciliation begins with review of daily cash collected in a cash register or other cash collection mechanism. It goes on to compare all expected cash receipts with sales paid by cash, credit cards, EFT, gift cards, etc. By matching amounts deposited in a bank account, an SME can determine whether processing is correct and timely.
All SME owners may benefit from a firm grasp of their business’ financial health. Reconciliation of financial statements, especially cash reconciliations, are an effective control to ensure accuracy for better-informed decision making and for mitigating fraud.
Kristina Russo is a CPA and MBA with over 20 years of business experience in firms of all sizes and across several industries, including media and publishing, entertainment, retail and manufacturing.
1. “Why is reconciliation important in accounting?” Investopedia; https://www.investopedia.com/terms/r/reconciliation.asp
2. “How to reconcile the general ledger,” AccountingTools; https://www.accountingtools.com/articles/how-to-reconcile-the-general-ledger.html
3. Small Business Credit Survey Report on Employer Firms, Federal Reserve Bank of New York; https://www.newyorkfed.org/medialibrary/media/smallbusiness/2016/SBCS-Report-EmployerFirms-2016.pdf
4. “Account Reconciliation: An Underappreciated Control,” Journal of Accountancy; https://www.journalofaccountancy.com/issues/2006/sep/accountreconciliationanunderappreciatedcontrol.html
5. “Employee Theft – Types, Why it Occurs and 7 Steps to Prevent it,” Fits Small Business; https://fitsmallbusiness.com/employee-theft/
6. “Steps for General Ledger Reconciliation,” Chron; https://smallbusiness.chron.com/steps-general-ledger-reconciliation-3920.html
7. “Importance of Monthly Balance Sheet Reconciliations for SMBs,” Greg Sonzogni, COO at TGG Accounting, via Linkedin; https://www.linkedin.com/pulse/importance-monthly-balance-sheet-reconciliation-smbs-greg-sonzogni