Why use clearing accounts in your accounting system for Paypal, Credit Cards, Amex, etc.?

In our highly connected, networked, real time information world, you'd think when you make a payment on a credit card, the amount is immediately transferred to the merchant (the business you're buying from).It is one of the banking systems little secrets that this isn't the case, and it's going to take a major change in the technology that underpins our financial system to change that. Banks & other financial institutions will tell you they're cutting edge from a technology standpoint - the real truth is they're not, with a few exceptions.

The underlying problem is that it takes 2-3 days for funds to clear through the various banking systems around the world. The more parties there are in between, the longer it takes. Technologies like block chain & smart contracts will eventually fix this, a discussion for another day.

For now, if you're an e-commerce merchant and you use a payment gateway to collect money from customers (whether that be a credit card, Amex or other payment forms), there is a delay in the funds coming into your bank account, normally 1-3 days.

So your workflows may look like without a clearing account:

  1. a customer checks out of your shopping cart
  2. you raise an "invoice" or "sales receipt" that increases your revenue and your accounts receivable in your accounting system
  3. you then pay the invoice in your accounting system against your bank account =:> this is where the problems start unless you're using Paypal

(For Paypal, this is how you do it:

  1. a customer checks out of your shopping cart
  2. you raise an "invoice" or "sales receipt" that increases your revenue and your accounts receivable in your accounting system
  3. you then pay the invoice in your accounting system against the paypal bank account you've set up. This should auto match against the bank feeds coming through from your paypal account. Work with your bookkeeper so that your workflows facilitate this. )

What will happen is your receipts from customers in your accounting system won't match the bank feeds. If you collect money on November 30th, it may not be in your bank account until December 2nd. You've crossed month end as well which compounds the problem - accountants and bookkeepers get most upset by an accounting system where the cash value on your balance sheet doesn't equal the bank statement. The bank feed technology in most cloud accounting systems was meant to address this, however the credit card clearing issue is still a gap.

Hence there's a step in between, which involves the use of the clearing accounts

  • a customer checks out of your shopping cart
  • you raise an "invoice" or "sales receipt" that increases your revenue and your accounts receivable in your accounting system
  • you then pay the invoice in your accounting system against your credit card clearing account
  • you then mark receipts that come in from your bank feed against that clearing account. Money in, money out.

The balance of the clearing account at the end of the month would be made up of two amounts (run a balance sheet and you should be able to see it):

  • amounts shown as "paid" in your shopping cart which haven't been received yet into your bank account. As a check, this is normally 2-3 days trading
  • most merchants now charge the merchant fee separately, rather than offsetting it against your receipts. If you have differences it could be your merchant facility is doing an offset still.
  • chargebacks from customers. These can be very hidden, the amounts can creep up on you if you're not on top of it. The clearing account reconciliation at least makes sure you're aware of them.

Is any of this ideal? I'm afraid not, there is substantial manual work in reconciling the amounts you get as receipts on your bank statement vs your sales from your shopping cart, with the different date just compounding the problem of matching these off.

Use a clearing account. At the end of the month, take a look at the balance. If it's substantially different to 2-3 days sales, it's worth digging into to see if you have leakage in your business due to the funky way the global banking systems work!

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