Can you tell if the financial information you are relying on is accurate or incorrect?

Most financial information from small businesses is unaudited, meaning an independent third-party CPA has never validated its accuracy. Even if a company is reviewed, the procedures are very limited and only catch obvious mistakes.

So, during a limited due diligence time frame, how can you make sure the financial information essential to the acquisition thesis is accurate? Enter the cash proof analysis.

What is a Cash Proof?

A cash proof analysis refers to the task of matching financial statements directly to bank statements. Bank statements are considered third-party evidence since the bank and not the Company is maintaining the data, so naturally the data is much more trustworthy.

We compare the inflows and outflows on the bank statement for each month to the corresponding amounts per the financial statements to ensure the amounts are in line. This catches any material duplicate or unrecorded transactions.

For example, if a Company earned $500,000 in a month (revenue plus change in receivables), but only $400,000 came into the bank account, this is indicative of an overstatement of revenue.

Difficulties in Preparing a Cash Proof

I highly recommend utilizing a financial due diligence / QoE specialist such as Petracca Group to perform a cash proof for two reasons:

First, the analysis is more technical than many expect due to accounting and other complications including timing differences, internal transfers, non-cash transactions, accounting adjustments, and, intra-period changes just to name a few.

Second, the analysis is another viewpoint the diligence provider should inspect to gain further insights into the flow of transactions. By looking at the financial information starting from bank statements instead of starting from just the financial statements, financial diligence experts can more accurately identify required adjustments.

The Main Limitation

A cash proof tells us total inflows match total revenue and total outflows match total expenses when considering the corresponding change in the BS. However, the analysis does not differentiate between classifications.

For example, it cannot directly catch if a marketing expense was incorrectly booked as a personnel expense.

How close is close enough?

Cash proofs are more difficult than they sound – you are trying to recreate the company’s accounting, but they have recorded thousands to even millions of transactions over the course of the diligence period, so ultimately you will not get outflows and inflows to match exactly.

Further, there are diminished returns as you whittle the difference downward, so it is not prudent to spend valuable time (and consulting costs) to get the numbers to match exactly.

Most providers find a difference of less than 5% acceptable, but we always aim for under 2% to gain additional confidence.

Contact us for further info!