I recently had someone ask me about the difference between a quality of earnings report and a proof of cash. They wanted to know what situations called for one or the other. Whenever an M&A transaction is underway, the deal must go through several layers of diligence. Sometimes a broker suggests just getting a proof of cash. Other times, a lender will ask for a QoE. Most of the time, a buyer hears about a QoE and just assumes it’s a more expensive version of the same thing. While they’re related, they’re not exactly interchangeable. If you’re wondering which one to get, I’ll break it down for you so you can be sure to get the most bang for your buck. What a Proof of Cash Does The main job of a proof of cash is to confirm that what shows up in the financial statements is grounded in reality. In CPA talk, we say “reconciliation.” We’ll compare the bank statements to the reported income to make sure deposits line up with revenue. We will also compare the disbursements with the expenses in the P&L. At this point, you’d have a complete proof of cash, but whenever we offer this service, we go a step further with what’s called “financial verification.” At this stage, we’ll first tie payroll records to payroll expense on the P&L. Then, we’ll make sure the book income is reconciled to tax returns, ensuring nothing has drifted too far from what was actually reported to the IRS. When we say a proof of cash tells you whether the numbers are “real,” this is what we mean. It confirms that revenue wasn’t overstated, payroll wasn’t understated, and cash was not overstated by adjusting journal entries. If your goal is simply to reduce the risk of things not lining up, a proof of cash will get the job done. What a Quality of Earnings Does Functionally, a QoE starts in the same place, but it definitely doesn’t end in the same place. Like a proof of cash, it does the reconciliation work to check whether the numbers tie out. Once that foundation is in place, it goes on to ask another question: Given how this business actually operates, are these earnings worth paying for? How repeatable are the profits for a new owner? Instead of only confirming totals, a QoE looks for patterns that provide insight into the value of the company. We examine profit and loss trends over time so we can see whether margins are staying stable, improving, or eroding. We’ll take a look at the balance sheet to understand how the business is funding itself and whether working capital behaves the way a buyer would expect after close. Then, we’ll test the seller adjustments and do some recalculations. Do the add-backs hold up under scrutiny? Would they truly disappear under new ownership? From there, we’ll provide an adjusted EBITDA as a way to understand the valuation of the deal. QoE reports also expose concentration risks. A business bringing in a million each year might not be as desirable once you learn there are only two customers. On the flip side, how do you value a company once you realize a single salesperson owns most of the relationships? These are real risks that need to be accounted for as you are negotiating a deal. Without a QoE analysis, they could easily fly under the radar and cause you to lose millions How to Choose Between Them To sum it up, choosing between a proof of cash and a quality of earnings boils down to what your goals are. If you want to confirm that the seller’s numbers actually exist and reconcile, then the right tool for you would be a proof of cash. If you want to know how those numbers translate into value, then you’ll want a quality of earnings report. To be clear, we always recommend a getting a full QoE. We believe it’s better to be safe than sorry when you’re making one of the biggest decisions of your life. Ultimately, though, it depends on the level of risk you’re okay with, and we’ll be happy to work with you if you decide a proof of cash fits your situation better. Whatever the case, if you’re trying to decide which approach fits your deal, I’m happy to talk it through. You can reach out directly or book a call to continue the conversation with me directly or with other searchers during our office hours.