What is Payment Reconciliation and How Does it Work?

Managing finances is essential for any business, regardless of its size. Without an effective system in place, you risk losing money on a daily basis. By the time you catch on, the losses could be staggering.

That's where payment reconciliation comes in. With payment reconciliation, businesses can meticulously track every penny entering and leaving their company. This allows them to compare their records with those of the banks, preventing losses and enjoying a range of additional advantages. These advantages include fraud prevention, efficient cash flow management, and more.

This blog will discuss payment reconciliation, how it works, and how integrating a reconciliation solution can help businesses optimize payments. 

Payment Reconciliation in the Digital Ecosystem

Payment reconciliation is an accounting process that involves comparing internal financial records with the bank's statements. The purpose here is to ensure records maintained in the general ledger (the company) match accurately with the ones generated by the bank. If they don't, it means there's a discrepancy on your or the bank's end, calling for an investigation.

How Does Payment Reconciliation Work and What Are Its Components?

There are three main components in payment reconciliation, i.e., bank statements, payment records, and accounting systems. The companies compare the payment records generated by their accounting systems against bank statements to identify and tackle any discrepancies.

Here's how the process works:

1. Internal Process

Internally, the organization saves a record whenever a transaction is created or scheduled. And this can be done using an automated accounting solution (the most efficient method). However, several companies rely on saving receipts and tracking paperwork, i.e., the manual effort for creating and maintaining records.

2. External Process

Externally, the bank records every transaction that is processed. This continues until a specific date each month, after which a statement is generated. The companies then compare this statement with their records and check for discrepancies. Any discrepancy in the records on either end (bank or the company) can be dealt with to avoid future miscalculations.

What are the 3 Types of Reconciliation?

There are three common types of reconciliation:

1. Bank Reconciliation

Bank reconciliation is one of the most common and complex forms of reconciliation. The sheer number of ways money flows out and inside the bank accounts makes this process complex.

The disbursements (payouts) and deposits are compared against the company's bank statements and books in bank reconciliation.

2. Credit Card Reconciliation

Both companies and customers use credit cards for making purchases. In this reconciliation type, the transactions listed in the monthly credit card statement are compared with the internal records maintained by the company. In addition, the transactions are compared with the bank statements that tell money was deposited or withdrawn to pay credit card bills.

3. Cash Reconciliation

This reconciliation happens at a physical store or shop. All the cash, cards, or checks collected in a register are compared with the sales receipts at the end of the day or before the shift changes. If the totals don't match, it could indicate an accounting error or an employee theft.  

Disadvantages of Not Having a Payment Reconciliation Solution

Not having an effective reconciliation process or process can lead to the following consequences:

1. Inaccuracy in Cash Balances

Without a reconciliation solution in place, your bank accounts may have less than the expected balance leading to bounced cheques or overdraft fees.

2. Fraud May Go Undetected

Reconciliation helps you identify and tackle any financial discrepancy. Without a reconciliation solution, you won't know which payments have been actually disbursed, leading to undetected attempts of fraud.

3. Cash Flow Disruptions

Not performing payment reconciliation will hamper your ability to identify delayed deposits and outstanding payments. And this can lead to cash shortages or even surpluses making it hard to meet financial obligations.

4. Poor Decision Making

Not having a reconciliation solution means you don't have an accurate estimate of how much cash you will have in your account. And this can lead to poor decision-making, further impacting your business's bottom line.

5. Unpaid Bills or Invoices

If you don't reconcile payments, you'd have no way of knowing whether all the issued invoices have been paid for. 

Advantages of Having a Payment Reconciliation Solution

Here are the advantages of having a payment reconciliation solution:  

1. Accurate Financial Records

Having a payment reconciliation solution means you can compare the financial records from multiple sources and ensure accuracy. This way, you can ensure not even a single penny goes unaccounted for.

2. Fraud Detection and Prevention

A reconciliation solution can help you identify suspicious attempts to loot money from the organization. This way, you can be more vigilant, prevent fraud and thus save money.

3. Effective Cashflow Management

Cashflow management is essential for any business to keep operations running and meet unexpected expenses. And reconciliation makes it easy. With payment reconciliation, you can identify discrepancies and accurately predict and manage cash flow.

4. Efficient Financial Reporting

As stated earlier, payment reconciliation can help improve the accuracy of your financial records. When you have accurate financial records, financial reporting also becomes more accurate. In addition, automated solutions help reduce the time and effort required to create financial reports, making the process more efficient.

5. Payment Optimization

Payment reconciliation offers insights into your cash flow and overall transactions allowing you to monitor your payments easily. Plus, you can reduce the likelihood of manual errors, detect any, and mitigate the same. This way, you can effectively optimize your payments.

What are the Common Challenges Businesses Face with Manual Reconciliation?

Several businesses practice reconciliation, but instead of leveraging an automated solution, they rely on human elements. And this leads to several challenges, such as:

1. Error Prone and Inefficient:

Manual reconciliation processes are often time-consuming and prone to errors leading to inefficient results. Employees have to manually compare the statements and records, which often results in delays and inaccuracies, making the entire process a mess.

2. Complex Transactions and Multiple Payment Channels:

If the transactions are as simple as credit and debit and a single payment channel is involved, reconciliation can be done quickly. However, if there are complex transactions (involving multiple parties and payment methods such as credit cards, banks, and wallets) involved, manual reconciliation can be a painstaking process.

3. International Transactions:

International transactions have numerous factors in play. For instance, there are different banking practices, engagement rates, differences in currencies, and what not. And considering all these factors manually with 100% accuracy is not possible, leading to inefficient reconciliation.

However, businesses can address these challenges by opting for an automated reconciliation solution. Let's learn more about such tools below.

Tools and Technologies for Payment Reconciliation

You can go for numerous automated payment reconciliation solutions that automatically match transactions and report discrepancies. Leveraging such solutions, you can reduce fraud, manage complex or international transactions and minimize errors.

However, if you want to avoid investing in a reconciliation software solution, you can integrate your accounting system with the bank's APIs. While this method is more challenging than a software solution, it does help get the job done and reduces manual input of manual elements, leading to better reconciliation.

Furthermore, you can opt for data analytics or reporting tools. Such tools offer you a hawk's eye view of all the payments in your system. You can use the available data to make informed decisions and optimize your processes.

Takeaway

Payment reconciliation is an essential accounting process for comparing internal (company's records) and external (bank or card) records to identify any discrepancies. With such a process in place, you can maintain accurate financial records, manage cash flow better, improve financial reporting, detect and prevent fraud and optimize payments.

So, if you don't have a payment reconciliation solution in place, get one now. Otherwise, issues such as cash flow disruptions, unpaid bills, fraud, and inaccurate cash balances might creep up in your business.