How to Reconcile a Bank Account and Why it Is Important

¶ … friend who is in a position of authority in a company should be aware of all accounts that the company has in the bank. Just because he is not a CEO or CFO in a company doesn't mean he should be ignorant about banking, about what is profit and what it is not, and how to reconcile money in the bank. Just having money in the bank means nothing unless what in accounts is fully vetted and understood in an ongoing flow of cash in and out.

Banks and Cash Management

The main reason for business failure is "poor cash management," according to Findlaw.com; poor cash management is also likely the "most frequent stumbling block" for those who go the entrepreneur route in business. Hence, understanding the very basic concepts of cash flow can help that person in the Introduction who has no clue as to whether the money in a bank account is profit or not.

Cash vs. cash flow: Cash in the bank is money, but it is not inventory, and it is not what you are owed by others (accounts receivable) -- and, money in the bank is not property (findlaw.com). Accounts receivable can in time be converted into cash, but it cannot be used in normal circumstances for paying bills, for example, paying suppliers or venders. Cash is what a company has on hand to keep the business running, but cash in the bank is not categorized as "profit"; in time, profits are "of little value if they are not accompanied by positive net cash flow" (findlaw.com).

Cash flow alludes to the movement of cash into and out of one's business. It is vitally important for the person in the Introduction to understand that keep a close eye on cash inflows and outflows is one of the " ... most pressing management tasks" for anyone in business (findlaw.com). Cash outflow refers to the money used (usually by check) to pay company salaries, to pay vendors and creditors (like banks, in case the company has a mortgage with a bank). On the other hand cash inflow reflects the money received from investors, customers, and lenders.

Positive cash flow: Having a positive cash flow means that the inflow has exceeded the outflow, which is pretty obvious, but it's not the only sign of good financial health, but it is one sign (flindlaw.com).

Negative cash flow: This is a case of the outflow of cash being greater than the inflow of cash. The important point here is that the manager or employee in charge of cash flow issues must know why there is a negative cash flow. That is, is the "accounts receivable" portion of the ledger not up to where it should be because customers have not paid their bill and there has been a poor job of collections? Or is it possible there is too much "obsolete inventory" -- and someone in the company has fallen down on the job of moving inventory off the cash flow pages?

Understanding the 3 components of cash flow (Findlaw.com)

Operating cash flow: This is what companies know as "working capital," the cash coming in to the company from sales of the product or the service that the company generates as the natural part of its business function.

Investing cash flow: When a company invests in the infrastructure of its own plant, or in equipment, or it invests in other "fixed assets," and uses cash that is outside of its normal day-to-day operations, it is called investing cash flow.

Financing cash flow: In this case, financing cash flow is cash "to and from external sources," like lenders, shareholders, or investors. Cash used to issue stock a paying a dividend to a shareholder falls under the financing cash flow category.

Practicing good cash flow management begins with a "cash flow projection," which smart business owners and entrepreneurs understand means both short-term (monthly or even weekly) and long-term (up to 3 to 5 years) cash flow. This helps when it comes to managing daily cash flows, and provides clear numbers when it comes to meeting business needs.

What is the difference between cash flow and profit? A simple way to justify income and expense for a company is to note that if " ... income exceeds expenses, there will be profit, but only if there's enough income to cover expenses" and to keep the company in the black as various necessary payments come due (toolkit). And what happens if someone makes a purchase but has not paid the bill for six months -- can the business still show a profit? The answer is yes if the "accrual accounting" is used the company can still show a profit; however, when it comes to the bills the company must pay during those six months

Cash flow and profit are two concepts as different as peaches are to walnuts. Profit is a "somewhat narrow" concept, and it only relates to income and expenses " ... at a certain point in time" (toolkit). But cash flow as a concept is far more "dynamic" because it is concerned with how money moves, in and out of a business, just like money moves in and out of checking accounts for private citizens. Moreover, cash flow (unlike profit) is very much a result of the time at which money's movement takes place (toolkit); when money moves is often as important as how much money actually moved, inflow and/or outflow.

Meanwhile, assets are what a company owns (including money and equipment); liabilities are what a company owes (bills, payouts to shareholders, etc.); and an owner's equity is the difference between assets and liabilities (basic accounting help).

The Basic Accounting Help website offers a classic example of assets, liabilities and owner's equity. A person buys a new computer (an asset) for $5,000. In order to buy the computer with cash the person has borrowed $3,000 (a liability), and the other $2,000 he took from his savings account. So, the way the equation should look:

$5,000 computer (asset) = $3,000 loan (liability) + $2,000 (owner's equity) in the computer (basic accounting help, 2008).

Understanding Basic Bank Reconciliation

The person mentioned in the Introduction certainly needs to understand the basics of how to reconcile his person bank checking accounts as well as how to understand the company bank accounts he apparently has a shared responsibility to monitor.

To begin with, a company has a general ledger account; in that account there is a record of all the transactions that have been performed. The checks that have been written, receipts from customers, and more, should be on record in the general ledger. The bank that is being used by a company also has a record of the checking account activities; those items include the checks written by the company, the deposits made by the company, any service charges associated with the account and possibly other items.