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Andreas Holtz8 min read

Cash Reconciliation: A Comprehensive Guide

Definition of Cash Reconciliation

Cash reconciliation means comparing internal cash balances against fund accounting and custodians to ensure all systems are in line.

It’s important to distinguish between:

  • Trade date cash, which reflects the cash balances from the day transactions are contractual (e.g. execution of an order)
  • Settle date cash, which is the cash sitting in the bank account at the custodian.

If the settlement cycle is 1 day (as for equities in the US), there will be 1 business day lag between trade date cash and settlement date cash.

Cash reconciliation for Hedge funds and Investment Managers

Here are the three providers or systems, whose cash balances should ideally be part of your fund reconciliation:

Party Description Trade date cash Settle date cash
Fund admin (or accounting system) The fund administrator will calculate cash for the NAV, typically per account and currency. Yes (because it’s what enters the NAV) No
Custodian The custodian will provide the investment manager with cash statements for each of its accounts – i.e. “cash at bank” information No Yes (because it’s what’s actually in your account)
Internal system (e.g. Investment Book of Record / IBOR) The internal system will calculate estimated cash balances. These balances will be for each cash account, per fund, and custodian. Yes Sometimes

 

Purpose

The primary purpose of cash reconciliation is to ensure internal control and:

  • Verify correctness
    • Ensure that cash has settled at the custodian
    • Verify that the correct cash has gone into the NAV
    • Verify that the investment book of record is calculating cash correctly, so that front office users can trust cash estimates intraday
  • Identify issues
    1. Identify and resolve discrepancies or errors promptly
    2. Detect and prevent fraud or unauthorised transactions
    3. Comply with control policies imposed by investors or the board

Or phrased more generally: reduce operational risks.

What cash to reconcile? (balances vs transactions)

Most often, it’s enough to reconcile cash balances (also called “cash positions”) – and not cash transactions. Cash flows can have three sources:

  • Fund administrator, e.g. deposits and redemptions.
  • The Order Management System (OMS) or IBOR, e.g. trades. If your OMS is also an IBOR, it can be the source of dividends.
  • Assets you own, e.g. coupon payments on bonds or dividends on equities.

It doesn’t make much sense for two data sources to send each other data and then compare that they have the same information.

The more helpful check is if the implication of the data sent is the same in both cases, i.e. the calculated cash balances.

Reconciliation diagram - light bg

Depending on your trading, it could make sense to reconcile transactions, including fees and commissions, before doing the cash reconciliation. The OMS would typically send a trade file to the custodian, which is the basis for settlement. If the information doesn’t match with the counterparty, trade settlement will fail. This is why using a matching platform or doing transaction reconciliation can be a good idea, especially if trade volumes are high.

By reconciling trades, you can find minor differences in commissions, taxes, other fees or even different trade dates or settlement dates before you reconcile the cash balances. It’s much harder to understand why there is a difference when comparing two cash balances than when comparing trade-level data.

Key Steps in Cash Reconciliation

Cash reconciliation involves the following steps:

  1. Import data
    Collect cash balance data from internal systems. The data is already there if reconciliation is part of your investment management system. Ensure data can be automatically imported from the custodian and fund administrator, ideally without being dependent on the vendor for such import and without having to write code (see Limina’s approach to data import here)
  2. Aggregate
    If data is already aggregated, e.g. by currency, in one source – you must aggregate the other source to compare at the same aggregation level. More on this below. This aggregation should be fully automated.
  3. Reconcile
    Match cash balances. The reconciliation tool will compare line by line, marking matching cash balances and flagging unmatched. Reasons for breaks can be value differences (within pre-set tolerances) or missing lines.
  4. Investigate Discrepancies & Resolve Breaks
    The reasons for unmatched cash balances or discrepancies are investigated. The investigation may involve communicating with front office users internally, custodians, brokers, or fund administrators. Depending on the reasons uncovered, the data in the IBOR is either updated or changes made at external parties should the error reside there. If the reconciliation engine is part of the IBOR, updating data can easily be fully automated (as is the case with Limina).
  5. Documenting for Audit
    All breaks and actions taken need to be documented. Such documentation is typically created automatically in a reconciliation tool.
    Note: There is no audit with Excel, so you must manage documentation manually if you use Excel for your investment reconciliation process.

Frequency of cash reconciliations

A cash recon is best performed at least as often as your NAV is struck. If your fund is daily traded, a daily (or even intraday) reconciliation is the best choice.

Side note on other types of recs: NAV reconciliation isn’t always required, and some firms rely on a combination of P&L-, trade-, cash- and position reconciliation as enough to claim shadow NAV.

Common Challenges in Cash Reconciliation

  • Manual errors
  • No IBOR
  • Data import/export

Data entry mistakes & spreadsheets

There are many flavours of how manual errors might be a challenge in reconciliation:

A. Manual data entry is time-consuming, error-prone and tedious. There is no longer any reason to enter data manually. If order raising is done by a rebalance to model, for example, an order or transaction never needs to be entered by a human into any system.

B. Spreadsheets are good tools for ad hoc analysis, especially for portfolio managers. They’re less good as steps in processes. Usually, when a spreadsheet makes it into a workflow or process, it’s a sign there is a workaround happening. In our studies, spreadsheet steps in workflows – including reconciliation – take up as much as 90% of the time to execute a workflow. They end up being time-consuming monsters. And are error-prone.

We recommend looking for a sophisticated solution where you don’t need to rely on spreadsheets.

SOLUTION:

  • Ensure system support for as many workflows as possible to avoid time-consuming workarounds. Limina’s system has been specifically designed to this end.
  • Ensure your systems have exception-based workflows, performing tasks automatically as much as possible and surfacing issues to humans for resolution.
  • Ensure your systems have data quality control functionality so you can configure data checks that will run in the background and surface any suspected issues or manual data errors.

Flush & fill Order Management System

If your Order Management System (OMS) Operates on a flush & fill model, it’s dependent on a start-of-day position and cash view from accounting. A cash or position reconciliation back to accounting is pointless for a flush-and-fill system - there is no duality since one view is created from the other.

The premise of duality is that two systems (e.g. your IBOR and the fund admin’s internal system) calculate independent portfolio and cash views. Those are compared, which creates a duality and catches most data mistakes.

SOLUTION:

Data collection & aggregation

A concrete example of a data aggregation challenge is a corporate action:

IBOR: The portfolio manager wants to see the P&L on the position and when the cash will hit the correct currency account.

Admin: The fund admin wants to track the P&L separately because corporate actions have separate accounting treatment (which might incur taxes and other fees).

Custodian: The custodian needs to track all cash movements (payment, taxes and any fees), potentially on specific accounts.

From a cash recon perspective, the challenge is worsened by the fact that the admin looks at trade date (ex-date in the corporate action example), and the custodian incorporates cash on settle date (pay date in the corporate action example).

SOLUTION:

  • Ensure that your fund reconciliation software can aggregate data in any way you require and that it can support both trade- and settlement date. We also recommend ensuring reconciliation is part of the investment management system (OMS and IBOR). Break resolution becomes easier because you can amend trades in the OMS/IBOR with one click or automatic rules.
  • With Limina, the OMS and IBOR can aggregate data in any way your heart desires, and powerful reconciliation is an embedded part of the solution. Book a demo to see it yourself.

 

Future Trends in Cash Reconciliation

Let’s explore some of the emerging trends and shifts in industry practices shaping the future of cash reconciliation.

Artificial Intelligence (AI) and Machine Learning (ML) in Cash Reconciliation

Artificial intelligence (AI) and machine learning (ML) technologies have already started to power cash reconciliation processes. AI-powered solutions can learn from historical break reasons and suggest the most likely reasons for breaks.

AI-powered solutions are, at the same time, not suited for automatic identification of discrepancies. This is because AIs are statistical models, so there is always a risk the AI will make incorrect decisions. In processes where the tolerance for error is zero, such as reconciliation, AI is therefore not suited for full automation but rather for highlighting recommendations to humans.

Outsourcing

Some investment firms have outsourced reconciliation to external firms specialising in cash reconciliations and break resolution. This can be either specifically for reconciliation or, more broadly, for middle office operations functions where cash recon is just one of the services provided.

Intraday reconciliation

Another shift is the move towards real-time or near real-time reconciliation. Traditional reconciliation processes often rely on end-of-day or batch processing, leading to delays in identifying and resolving discrepancies. As some fund admins and custodians have started to offer real-time data feeds and advanced reconciliation systems, investment managers can now perform continuous reconciliations throughout the day, enabling quicker detection and resolution of issues.

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Andreas Holtz

Experienced client relations professional with a proven track record of building and nurturing successful client relationships, bringing a strategic and customer-centric approach to every interaction.

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