Kyle Maloney
September 10, 2022

A Guide to Financial Reconciliation, Part I: The Basics

In this post, we cover the basics of reconciliation and why it's important for companies that move money.

Introduction

When it comes to moving money on behalf of your customers, there is a lot to consider. From choosing the right payment processors, ledgers, and bank partners - to stitching everything together into a great user experience - there are many non-trivial decisions to get right.  And this is especially true when it comes to the back office infrastructure required to manage & operate financial services products.

As much as we’d like it to be simple, money movement is complex - it involves tracking, managing, and accounting for each transaction across the full payment lifecycle - a lifecycle that involves complex scenarios, edge cases, and funds flows. This means that financial operations processes are critical.

And for companies who move money, there is no more important process than reconciliation. But reconciliation is often not well understood - in terms of what it is, why it is so critical, and how to do it well.

So in our new series, A guide to financial reconciliation, we're unpacking this financial operations process to provide a foundational understanding for product and finance teams. Today, we’ll cover the basics, and in future posts, we’ll dive deep into the nuances, covering common problems, best practices when managing ledgers, and guides for performing different types of reconciliation.

What is reconciliation?

Reconciliation is the process that ensures that each transaction on your system of record agrees with your bank, payment partners, and your internal expectations. It may seem trivial on the surface, but payments are a uniquely complex blend of technical, regulatory, and business requirements. And ensuring that financial data is accurate across sources is a critical function of financial operations, ensuring that value isn’t being created or destroyed.

Why is reconciliation important?

Reconciliation is important for companies across every stage, from early stage startups to public financial institutions. It is the critical building block of financial operations processes, and serves multiple functions. 

Ensuring money movement matches your expectations

In payments, we often say that it is not a matter of if something unexpected will happen, but when. And when money is not in the right place, reconciliation is the process that makes you aware and allows you to take the proper steps towards resolution. Some common scenarios include:

  • Edge cases - when it comes to ACH, card issuing, acquiring, there are hundreds of unique journeys that a payment can take through its lifecycle, each with an implication on where funds should ultimately end up. 
  • Technical issues - today, payment data is regularly transmitted via HTTP, flat files over SFTP, and in batch processes. Though these protocols are generally reliable, there are regular issues with data exchange between parties. 
  • Duplicates - duplicative data is an issue for any application, but can be especially problematic when it comes to payments data. Reconciliation helps identify these issues and prevent negative financial impacts.
  • Asynchronous data - across the financial ecosystem today, most money moves asynchronously via batch settlement. Reconciliation ensures that the money that was expected to move actually did.

Ensuring successful financial and regulatory audits 

Bank partners, processors, and regulators can routinely request details related to transaction data and customer balances. Reconciliation not only ensures that the reporting you provide is accurate, but it enables you to show how you know it is accurate. 

In future posts, we’ll explore the concept of financial controls and auditable exception handling. 

Empowering finance and product teams to make good decisions and operate efficiently

Without a great reconciliation process, finance and product teams are often not able to confidently know where cash balances stand or close the books quickly at the end of the month. This is especially true of companies that provide any kind of financial services to their customers. Often times, product and finance teams are in the dark - and when issues arise, roadmaps slow to a halt as product, engineering, and operations teams go searching for needles in a haystack. 

Maintaining a great customer experience

Customers are ultimately impacted when money goes missing. Even if 99% of your payments are successful, a single payment that does not arrive on time or in the expected amount could mean huge distress & negative impact to your customer, especially for large transaction amounts like paychecks or vendor payments. 

A typical reconciliation process

We’ll explore the nuances of types of reconciliation processes in future posts, but most simply, reconciliation will involve at least three primary data sources that must be in agreement: your core ledger, your payment processor(s), and your bank account.

  1. Your ledger acts as your internal record of money movement. This may be a billing system, an internal online ledger, or a third party ledger as a service. 
  2. Your payment processor can broadly be considered the initiator of money movement. This may be a third party provider, a bank, or an internal service at your company. 
  3. Your bank account(s) represent the current state of money movement across your business.

Each source will be reconciled to the others, ensuring three-way agreement across internal and external sources of truth. The reconciliation process should care for timing differences, different transaction states, and segmentations of different transaction types. For each payment type, heuristics and logic will be applied to fully reconcile transactions across each type of money movement.

Types of reconciliation

Transaction reconciliation

Transaction reconciliation ensures that all transaction events are consistent across services (internal & external). This means that a transaction reconciliation process will not only check the validity of transactions across sources but will also verify that the transaction state and metadata are consistent. There are different levels of resolution that can be achieved, from simply verifying that transactions exist in the right amount across sources, to verifying the state, direction, accounts, and transaction metadata.

For example, a company issuing cards reconciles all transactions from their issuer processor to the transactions on their ledger. Because card payments have unique settlement timing, the company would not only verify transaction amounts, but transaction states, cardholders, and direction, to ensure that they have appropriately accounted for different payment types and balance adjustments.

Balance reconciliation

Balance reconciliation ensures customer balances are accurate and that account codes have been properly applied. Balance reconciliation is critical when managing lines of credit, FBO's, and regulatory requirements for FDIC Insurance or money transmitter licenses.

For example, a fintech who stores money on behalf of their users may have many different money movement types that could affect a single customer's balance. For example, a neobank may offer ACH, P2P, & Card issuing, and may provide both a checking and a savings account. The company would leverage a balance reconciliation system to verify the accuracy of balances over time. When a delta between actual and expected balances form, a performant balance reconciliation system will help identify when the balance delta began, relative to all the transactions applied to the account. This can then be used with transaction reconciliation to find the exact causes of the balance mismatch.

Bank reconciliation

Bank reconciliation ensures that end of month bank statements are consistent with internal records for account. This process verifies that all funds movements are consistent across a period of time and allows companies to pinpoint potential issues related to payment operations or automated funds movements with their banking partners.

All companies do some form of bank reconciliation, but for financial services companies, this can be more complex. Typically, in addition to maintaining an FBO account, companies reconcile their operating and reserve accounts with their partners, to ensure that their cash positions and total exposure are fully reconciled for audits and month end close.

Cash reconciliation

Cash reconciliation ensures that money movements are reconciled and verified from initial order to settlement across your financial system, including your core accounting system. Recognizing revenue can be a challenge, but it can be uniquely challenging for financial services companies, where managed funds movement has a direct impact on revenue. Interchange, fees, and exchange income reconciliation involves a blend of financial data sources and internal logic to verify accuracy for financial reporting.

Conclusion

There's a lot more to unpack when it comes to reconciliation and financial operations. In Part II, we discuss common reconciliation problems & best practices when managing ledgers. In future posts, we'll provide guides for performing different types of reconciliation.

If you are looking to improve your reconciliation processes, Proper provides financial data infrastructure, purpose-built for fintech. We help stitch together sources of financial data into a single platform and provide tools for reconciliation and financial operations. Back office infrastructure is critical to financial services, and with Proper, companies can spend less time on financial ops tools and more time focused on their end-users.

We’re modernizing the systems that many innovative fintechs are forced to build in-house and providing services that you can integrate quickly to expedite your financial operations stack.

Kyle Maloney
September 10, 2022

Some more posts

Global Money Movement, Part I: The Basics of Multi-Currency Transactions

In this post, we cover the basics of multi-currency transactions for those looking to begin storing and moving funds across borders.

Travis Gibson
September 21, 2022

A Guide to Financial Reconciliation, Part II: Reconciling a Product Ledger

In this post, we cover common challenges and best practices for reconciling a product ledger.

Kyle Maloney
September 15, 2022

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