What's payment reconciliation? Functions, types, & how to Automate it

The other day I was talking to a customer, and she mentioned that investing in a payment reconciliation solution has been the best thing that has ever happened to their department. Although the team was skeptical in the beginning, now payment reconciliation is an essential tool in their solution setup that they would never give up on.

That made me think: why are so many companies still manually doing their payment reconciliation and accounts payable reconciliation processes? What does the manual process look like, and how could automatic reconciliation improve the efficiency of the matching process?

To start, we will look at what reconciliation is, only to dive deeper into the manual process and the requirements to achieve full automation to reconcile payments faster so that the accounting team only needs to deal with the discrepancies.

What is payment reconciliation?

Payment reconciliation is an accounting process to compare two sets of records, usually the internal record and the bank statement, to validate that they match so that you make sure that all payments have been received and recorded correctly. Businesses reconcile their payments daily, weekly, or monthly. In case of any discrepancies, an accountant needs to investigate and correct them. This can be done manually or through automated payment reconciliation software, however, in many companies the process is still rather done manually in an inefficient way, costing businesses both human resources and time.

Payment reconciliation is an integral part of accounting and is typically performed regularly. By reconciling payments, businesses can ensure that they are not missing out on any revenue and that all expenses have been properly accounted for.

While the reconciliation process is straightforward, it’s a challenge when a business has hundreds or thousands of accounts payables and accounts receivables. In addition, manual payment reconciliation can be labor-intensive and error-prone, and companies are looking to automate their payment reconciliation processes.

Reconciliation and matching: are they the same?

The concept of reconciliation and matching are closely knitted. When an account is reconciled, the statement's transactions should match the account holder's financial records.

In other words, reconciliation is the matching of info such as accounts receivable or accounts payable fetched from the ERPs or client systems with open items in the bank statements.

Items (such as entries from sales or purchases) are considered as outstanding until you match them to bank statements. Bank statements are the proof of whether a payment has been made or received.

When outstanding items are matched with a bank statement, you gain a clearer and more accurate financial picture of your company.

There are two main steps, divided by sub-steps which best summarize payment reconciliation:

Inward (aka internal) Reconciliation

Inward reconciliation involves collecting and recording a transaction such as a payment or billing info. Financial software, manual paperwork processing, saving receipts, and managing an Excel spreadsheet of payment records are a few of the ways you can perform inward reconciliation. There is a high risk you may be swamped with paperwork and manual work if there are, for example, high volumes of incoming receipts.

Outward (aka external) reconciliation

At the same time as the internal reconciliation takes place, banks provide the business with monthly statements which include payment transactions, balances, and financial activities. The business should then relate the statements from the bank with the internal accounts (such as the incoming payments) and verify that there are no discrepancies. When those discrepancies and errors are spotted, the business should investigate the reasons why those arose in the first place.

How does payment reconciliation work in practice?

Payment reconciliation is usually done daily, weekly, or monthly. The more invoices a company needs to deal with, the more sense it makes to reconcile payments daily.

The process typically includes the following steps:

1. Collect all the data

You need to retrieve all internal and external records to start with the reconciliation process. Manually, the more entities and banks the company has, the more time it will take to do that. With treasury management software (TMS), the internal data can be found already there, or it can be retrieved through integrations from all other systems, and bank accounts are also connected to get the bank account statement automatically.

Manually, the process is once again labor-intensive, and it’s often a waiting game: you need to wait for all stakeholders to submit their data before starting the process.

2. Matching

During the matching phase, all payment records are compared with the records included in the bank statement to ensure that all unmatched items can be corrected. This process can be a subject of automation.

3. Reconciliation

Items that match do not need further review and do not need to move to the next phase. Unmatched items need to be sent for further review to the responsible accountant to find the discrepancy.

While the error may be in the internal records, verifying that the bank statement is valid is also a good practice. In case it includes errors, get in touch with the bank to find the possible error.

4. Finalization & posting to the general ledger

Once all the items have been reconciled successfully, the records can be posted to the general ledger.

The challenges of manual payment reconciliation

The main challenge of manual payment reconciliation is definitely the fact that it’s extremely labor intensive when there is a large number of accounts payables and accounts receivables. It is also a task prone to errors when the accountant must deal with large data sets.

Another issue is retrieving the data – the more ERP and financial systems a corporation has, the more time-consuming and challenging can be to consolidate all the data. The same is true for bank statements: enterprises may have hundreds, if not thousands of bank accounts. In these complex cases, reconciling payments manually is not a viable option.

The last challenge is the posting to the general ledger of all the reconciled items – this could be also automated upon reconciling all the payments.

Different types of Payment Reconciliation

Depending on the nature of your business the types of reconciliation may differ. Payment reconciliation may be composed of disbursements (such as operating expenses such as rents, and interest payments on loans), accounts receivables and payables, direct debits, eCommerce, digital wallets, and others.

The main types of Payment Reconciliation are the following:

Bank reconciliation

Bank Reconciliation is a procedure of crosschecking that the business’s end-of-day cash balance on your internal records matches the closing balance on the bank statement. To avoid hidden bank service fees, unrecorded transaction fees, and penalties from missed payments, it is important that you reconcile your records against the bank statements. It is essential that all bank fees such as those coming from bouncing checks are checked and recorded.

Cash reconciliation

No matter the type of business, cash reconciliation is essential in monitoring the movement of the cash flow by crosschecking the company’s ledger. The higher the volume of transactions, the more challenging the cash reconciliation can be and therefore an automated cash reconciliation becomes a necessity.

Credit card reconciliation

Credit card reconciliation is the process of verifying that the records in the credit card statement mirror the records on the company’s general ledger. If the ledger does not match the credit card statement, the discrepancy needs to be investigated as to the cause and the person who made the payment.

To summarize, we want the business’ internal accounting records to mirror those records that appear on the business’s bank statements with a matching ending cash balance.

How to automate payment reconciliation?

Automation can help improve the efficiency of all the steps included in the reconciliation process.

1. Import all items automatically from your source systems

The first step is to ensure that all unmatched items are automatically retrieved from the source systems to prepare for the matching process.

2. Define your matching rules

Companies require different matching processes so the process can be defined to match your needs and utilize the so-called rule-based matching. For example, rule-based matching can be used for balance matching, AR & AP matching, lockbox matching, or e-commerce payment matching.

3. Connect with your banks & fetch bank statements

The integrations did not end with connecting your ERP and financial systems. To fully automate the process, creating connections with your banks is necessary to automatically fetch bank statements before the automated matching can kick in.

4. Match all internal data with external data

Match your internal data against external data from bank statements.

5. Exception handling

Unmatched items, so-called exceptions, will be forwarded for exception handling that can be reviewed.

+ 1. Enrich the data

Automatically enrich the data from various sources before the matching process to improve data quality and thus increase the percentage of automatically matched invoices.

Automated payment reconciliation to improve the matching process efficiency

Automated payment reconciliation is an excellent way to improve matching process efficiency. With payment reconciliation software, the process can be easily improved so that your team can focus on more meaningful work, such as enhancing finance and accounting processes.

Reconciliation software often also helps with understanding the level of unmatched transactions so you can identify if there could be potential improvements to reduce unmatched items to the minimum in the future. Using a solution that provides a rule-based framework, the process can be continuously improved to increase the automation ratio. The solution should also be flexible so that admin users could easily make changes to the matching and posting rules so that changes can be implemented rapidly to meet your organization's needs. With a tool, the team can also implement better reporting per matching process or entity that can be useful for future improvements.

What are the benefits of automated reconciliation?

Customer Satisfaction

A reliable automated reconciliation tool allows you have an up-to-date picture of the incoming payments and the invoices that have been paid. In this way, the business avoids damaging its customer relationships by sending reminders for payment letters. Not having proper visibility of whether the customer has exceeded their credit limit may hinder even further sales. If the customer has already paid the invoices but their account is frozen because the credit limit appears to have been exceeded, the customer will not be able to make any new purchases.

Save Time and Reduce Manual Work

Automated reconciliation frees up more time to focus on unidentified transactions and sort them out. The staff is spending less time manually looking through countless records and focuses only on major discrepancies that the system has pointed out.

Reduce Fraud and Increase Transparency

With its speed and accuracy, an automated Payment Reconciliation tool can spot repetitive errors and fraudulent activities and errors quickly, therefore, allowing the relevant personnel to act fast and solve the issue. At the same time, an automated reconciling tool provides a clear view of all the company’s transactions and closing balances.

Develop your Business Continuously

When the reconciliation process is harmonized and automated being performed using a single tool, the reporting process becomes more efficient. With clear reports, the business can map the usual errors or discrepancies and gain insight into the invoicing process. The staff can then focus on improving the record processing, spot repetitions, and developing the automation tool further. Modern matching solutions such as Nomentia Reconciliation allow the user to flexibly create new automation rules that specifically fit the business’s needs. Nomentia Reconciliation utilizes machine learning algorithms to help the user optimize the process.

Should you automate payment reconciliation?

Payment reconciliation is a cost-effective way to gain efficiency and improve your operations. While there is an initial investment to set up the integrations between your systems and banks (unless you are already using a payment hub that provides an add-on reconciliation solution), after that for a monthly fee, you can automate the process and free up your team from the manual task of matching and posting transactions.