Undeposited funds is a holding account for money a business has received but has not yet paid into the bank.
Why the account exists
A business taking several payments in a day usually banks them together. The bank shows one deposit; the records show several payments.
Undeposited funds bridges that. Each payment is recorded against the customer as it arrives and sits in the holding account, and when the deposit is made the individual payments are grouped into the single amount the bank will show.
Without it, one bank deposit cannot be matched against several customer payments, and reconciliation becomes guesswork.
What a growing balance means
The balance should return to zero, or near it, every time a deposit is banked. A figure that only ever rises generally means one of three things.
Payments recorded and never deposited — the money is genuinely sitting somewhere uncounted, in a drawer or a safe.
Deposits entered directly to the bank account instead of being grouped from the holding account. The bank side is right, the customer payments are still recorded as pending, and the same money is counted twice.
Payments recorded twice — once when taken and again when the bank showed it.
The second is the most common by a wide margin, and it inflates both income and the apparent cash position.
Why it matters to the figures
Undeposited funds is an asset, so it is included in what the business appears to hold. Where the balance is wrong, the cash position is wrong — see real cash balance and books versus bank variance.
Clearing it
Bank what is genuinely undeposited, and correct the entries for anything already banked. Where the balance has been growing for a long time, the correction is a bookkeeping exercise rather than a missing pile of money, and it is worth having an accountant unpick it once rather than adjusting it repeatedly.
Cash businesses
A trade taking cash on site carries the largest exposure here, because money genuinely can sit uncounted — see petty cash and fraud prevention.