Proof of cash, proof of revenue is vital as it's a major component of your analysis.
If there are material discrepancies between what is being reported on a cash basis from the bank side of things compared to the financial statements, you need to double click and ask management why some of these items are not reconciling before you go ahead and complete a business acquisition.
The objective is to verify a company's revenue by comparing detailed financial reports to the bank statements.
The proof of cash looks to portray an accurate financial picture by comparing what is per the bank statements compared to the QuickBooks reports or the other financial statements.
It helps with what I like to call the fraud check or it's a gut check.
The bank statements don't lie. They cannot lie.
The reported revenues in QuickBooks can be manipulated in the form of accounting entries that don't relate to real revenues. They could have changes in accounting policies and procedures that materially inflate revenues based on how they're reporting it.
The bank statements simply show activity of the company's operating history. When they pay bills, you see disbursements. When they receive collections from invoices, they receive credits or cash receipts.
You want to select an appropriate period and identify what month are you going to analyze.
It's best practice to at least do a minimum of the last trailing 12 months.
Typically financial due diligence is conducted over at least a three-year historical period plus the trailing 12 months.
From a risk standpoint, I would start with the most recent trailing 12 months and then work backwards because valuations are based on the trailing 12 months or the last 24 months.
That is your period that's most impactful in terms of valuation typically in practice.
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If you’re starting your search or actively searching, you could be in that stage for several months, even up to a year or 18 months.
The challenge with speaking to providers too early is that without a specific business or industry in mind, it’s difficult to give valuable advice on how to diligence a specific deal.
Once you identify a business you’re seriously considering and plan to submit an LOI, that’s when it becomes appropriate to book a call and reach out to a provider.
After your LOI is signed and formalized, you can quickly commence due diligence. Often your signed LOI and your Quality of Earnings project will start within the same week.
You can find this and other content on my YouTube channel, including shorts, long-form videos, and guest discussions focused on buying small businesses and improving operations.
If you want to reach out on LinkedIn or X, share feedback, or suggest topics, feedback is a gift.
When you're compiling this cash proof, you want to exclude some of those non-revenue transactions.
Things like internal bank transfers from one bank account to another.
Those may appear on the bank statement and would be captured in your deposits, but you wouldn't expect the company to record those items as revenue.
If they did, that would actually be a misclassification.
Other typical nonrevenue items I see on the bank statement could be things like loan proceeds.
If they received an inflow of money from a line of credit or a PPP loan, those items should not be reflected as income like reported revenues.
If you fail to remove internal bank transfers, this analysis is not going to work.
We are comparing cash receipts per the company's primary operating account to the revenue as reported in the company's QuickBooks.
The risk for a proof of revenue is the company is reporting revenues that are higher than cash receipts.
Mon-to-month variances should be investigated.
If you can get a total variance over 12 months within plus or minus 2%, it gives me comfort and a stamp of approval that there aren't material discrepancies in the financial statements.
If the revenue per book is higher than the adjusted revenue per bank, there is a risk that the company is overstating their revenue.
If accounts receivable increases from one month to the next, there's more revenues that are being tracked on the revenue side per book, but they're not being reflected in the bank statements.
If AR increases, it's a non-cash activity.
You would debit accounts receivable and credit reported revenue per book.
So that revenue number is going to increase but there's really no bank activity.
In order to correctly compare cash receipts per book to the cash receipts per bank, that AR amount needs to be reduced from revenue as reported.
If AR decreases, cash comes in the door.
When AR decreases, you need to add those cash amounts collected which reduced AR.
Those changes in AR are very important.
Making sure you get the change in AR correctly on the book side is where you're going to be able to resolve a lot of your problems.
When you're conducting the analysis, I encourage you to flag variances and ask questions rather than look to reduce the variance.
This analysis should be a collaborative conversation with management.
The purpose of this analysis is to ensure cash receipts per the book are in line after reflecting balance sheet changes per the bank account.
If there are material variances, you need to understand what's happening.
If they were unable to provide sufficient support, that could be an example of them accidentally recording revenues incorrectly.
If you fail to remove internal bank transfers, this analysis is not going to work.
Incorrectly typing in the numbers is another big one.
Garbage in garbage out.
Make sure you're typing in the actual deposits correctly.
Conduct a final review across all tested months.
Double check all your numbers against the bank statements.
The proof of expense does the exact same thing.
It compares the total adjusted cash disbursements per the bank to the expected cash disbursements per book.
Accounts payable relates to your proof of expense.
If accounts payable goes down, there's likely a cash component that's being paid to reduce that amount.
AP and AR are both evaluated. One is on the proof of revenue and the other side is on the proof of expense.
In total, the cash receipts as reported compared to the cash receipts per book was under 1%.
That gives comfort.
What you're looking for on the revenue side of things is plus or minus 2% as an appropriate variance.
You might want to dig in further if there is a risk that the company is overstating their revenue.
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