Reconciliation: The Cornerstone of an Efficient Treasury

The need for reconciliation stems from the fact that two parties may have somewhat different views on the same transaction. This could concern anything from an invoice payment amount to the conditions of an interest rate swap agreement. It is important to quickly identify any deviations – due to differences in opinions or administrative errors – in order to ensure that the transaction leads to the intended financial effect. Reconciliation is also an important tool for identifying fraudulent behaviour. Reconciliation processes are a cornerstone in any internal control and governance framework. They are also included in most ‘good practice’ guidelines, audit controls and official regulations, such as the Sarbanes-Oxley (SOX) Act.

Apart from the control aspects, there are also efficiency consequences to consider. If errors are caught early, they will usually require less effort to rectify. Error handling is the greatest obstacle to efficient processes. Reconciliation can also expedite the removal of factors that lead to delayed payments, thus reducing the working capital required.

The Solution

In order to perform reconciliation, it is necessary to have access to the data to be compared from the two sources. One source is the company’s own systems, for example:

  • Current account in the general ledger (GL).
  • Customer account in accounts receivable (A/R).
  • Transaction journal in the treasury system.

The other source is often the bank:

  • Transactions on bank account statements.
  • Payment information on receipt advices.
  • Trade details on deal confirmations.

The challenge is to obtain the information in a comparable format. In order to automate the process, the information has to be available in electronic format. Currently this is not usually difficult. Most enterprise resource planning (ERP)/treasury management systems (TMS) can export the relevant data. Most banks can also provide information in different formats such as EDIFACT and SWIFT message types or variations of these.

The hardest part is often to make sure that all parameters to be used in the reconciliation are included in the files. It is important that the bank reporting the information does not leave out or truncate any transaction information fields, for example, full payment references. In some cases, payments are aggregated into a single transaction on the statement. In this case it is important that the bank can decompose the gross transaction and report the detailed transactions needed for reconciliation. The process can also be facilitated if the bank can compile information from several bank-internal sources (and even from other banks) into a single file, thus reducing the need to merge several separate files before reconciliation.

Once the reconciliation data is in place, the next step is to have the matching mechanism to feed it into. Of course, one can start out simply by building a matching algorithm in the spreadsheet application of choice. However, it does not take large volumes to justify a professional tool. A large variety of reconciliation software is available in the market. The systems can be of the following types:

  • Modules included in ERP/TMS systems.
  • Stand-alone systems from third party vendors.
  • Systems provided by banks and business process outsourcing (BPO) operators.

In some cases – particularly when using information from several different sources, for example, banks – there might be a need to clean up and standardise the data before using it. Some of the systems have functions for this, for example rules to deal with different formatting of payment references.

The basic configuration of the system consists of defining the parameters to be used as the basis for reconciliation. The systems also have different functions to improve the matching rate, for example rules for grouping transactions, threshold values for acceptable deviations, etc.

When the reconciliation process is run, hopefully, the bulk of the transactions will be matched automatically. The greatest benefit of automatic reconciliation is that discrepancies can be focused on and dealt with quickly.

Figure 1: Automatic Reconciliation

Source: Handelsbanken

In the payment area, the reconciliation problem has been recognised by many parties and has also been addressed in the single euro payments area (SEPA) rulebooks. The rules for formatting and transportation of reference information from the sender to the recipient will facilitate the process.

The file communication that constitutes the basis for the reconciliation of payments is depicted in Figure 2.

Figure 2: File Communication for Payment Reconciliation

Source: Handelsbanken

Client Case Study

To demonstrate what can be achieved, I will briefly describe a project that was performed by one of our clients, a large Nordic company. Improvements of the reconciliation processes were part of a group-wide initiative to cut costs by 25% during a period of two years. The activities included centralisation of the payment functions and the introduction of a common ERP system.

When the project started, the company received about 70, 000 payments a month. Out of these, approximately 90% were reconciled automatically. The project manager responsible for the A/R processes estimated that every percentage point corresponded to the cost of one staff person. The target was set to an automatic reconciliation rate of 97%.

In order to reach the ambitious target, organisation, processes, and systems were scrutinised. It was decided that the reconciliation function of the new ERP system was to be used. The information delivered from the bank was of utmost importance. The bank helped by identifying repeated incorrect information from the remitters. These customers were contacted and asked to update the payment information in their systems. Another activity was to redesign the invoices so all payment instructions were presented together and in a clearer way.

The different activities resulted in the target being reached. The client is very satisfied and the matching rate is now monitored monthly to make sure that the effect lasts. The project manager believes that it would be possible to improve the matching rate somewhat further but that the cost would probably exceed the benefit. The project manager also points out that even though the project was primarily cost-driven, other positive effects – such as improved control and security – has also been achieved.

How to Start

So, where to turn if you want to review and improve your reconciliation processes? Banks are used to assisting their customers with optimisation of payment and reconciliation processes. This experience enables them to provide advice in the area. Control issues like these are, of course, also familiar ground for audit firms (and their consulting arms). The system vendors providing reconciliation software often also assist in implementing their solutions.

Conclusion

As cash management advisers, we are surprised at the number of occasions when we realise that even quite large clients have neglected to fully reap the benefits from automatic reconciliation. After all, compared to many other treasury/finance solutions, implementing a reconciliation service is of limited complexity. Although it is not one of the ‘sexiest’ financial activities – which might explain why it sometimes doesn’t receive adequate attention – a well-designed reconciliation process is a cornerstone in any efficient and secure treasury/finance operation. It will also be greatly appreciated by the staff, since it will remove one of their most tedious tasks.

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