Filed under: 10 Challenges In M&A Transactions, Advisory, Private Business, Proof Of Cash
September 27, 2024
Whether you are looking to buy or sell a company, cash flow activity will be a key measure of performance and value. The reliability of revenues and EBITDA as key reporting indicators is critically important. If a company has not had a financial statement review or audit conducted, additional steps will need to be taken to gain an extra level of comfort that revenues and expenses are complete, accurate, and connected to an external source.
An alternative analysis that can be performed in the absence of a review or audit is a Proof of Cash. Essentially, a proof of cash shows how total deposits and disbursements from bank accounts are reconciled to revenues and expenses reported in a company’s accounting system. While this may sound simple, it can actually be a bit tricky. The following is a discussion on how a proof of cash is performed and things you should consider.
Cash Inflow
Deposits on bank statements show the total amount of cash the company received within a specific period. However, total deposits are likely not 100% related to revenues earned by the company.
Cash inflows are not limited to just revenues. They can include various other sources such as interest and dividend income, owner’s contributions, transfers between company bank accounts, and sales tax collected from customers. Other sources may include proceeds from new loans or lines of credit, insurance, and government-related tax credits or relief programs.
If the company maintains its books on the accrual basis of accounting, there are additional adjustments to consider. Such adjustments include changes in the accounts receivable and deferred revenue account balances, customer deposits or advance payments, and deposits in-transit at the start and end of a specific period. These all represent timing differences between when cash has been deposited, but not yet earned as revenue.
After considering all these adjustments, you can reconcile total deposits on the bank statements with the adjusted revenue figures from the accounting system.
Cash Outflow
The disbursements reflected on bank statements represent the sum of cash used within a specific period. These disbursements could be for different purposes including, but not limited to, covering normal operating expenses, inventory or capitalized assets, loan payments and interest expense, owner’s distributions, transfers between company bank accounts, remittance of sales tax collected from customers and other tax payments.
If the company’s books are maintained on the accrual basis of accounting, it is necessary to account for additional adjustments including changes in accounts payable, as well as other current asset and liability accounts. Checks that remain uncleared at the beginning and end of a specific period should also be factored into the proof of cash calculation.
Upon considering all these adjustments, you can reconcile total disbursements on the bank statements with the adjusted expense figures from the accounting system.
Summary
The analysis of adjustments—changes in accounts payable, difference in accounts receivable and deferred revenue, etc.—is typical and would apply to most companies. However, given that each company has its own unique operations, additional adjustments may be required. Instances of substantial discrepancies between deposits and revenues, or between disbursements and expenses, warrant further investigation to reconcile these differences. Upon completion of the Proof of Cash analysis, you will gain a more transparent perspective of the cash flow within the company and have a connection to a third-party source. This should, in turn, enhance your confidence in the revenue and expense figures presented in the financial statements.
Do you have further questions or are interested in gaining assistance for a Proof of Cash analysis? Reach out to us and we’ll be happy to help.
© Clark Nuber PS, 2024. All Rights Reserved.
