Proof of cash: checking revenue against bank deposits

Say a seller's profit and loss statement shows $960,000 of revenue last year, and the tax return agrees. That's a good start, but both documents came from the same set of books, kept by the same people. If the books are wrong, both will be wrong in the same way.

Bank statements come from somewhere else: the bank. A proof of cash (accountants also call it a cash proof) checks the books against them. It rebuilds the money that came in and went out from the bank records, then compares it with what the company reported. It's one of the most useful checks a buyer can make, and you can do a rough version yourself with a spreadsheet and a free weekend.

If you haven't yet compared the books with the tax returns, do that first. Our post on tying the tax returns to the books walks through it.

What you'll need

Ask the seller for these, after you've signed a confidentiality agreement:

• Statements for every business bank account for at least the last 12 months, and ideally the last two or three years. That includes savings accounts and any account at a second bank.
• Revenue by month from the company's books, for the same months.
• Card processor statements, if the company takes cards.
• Forms 1099-K. Card companies and payment apps report payments to the IRS on this form. According to the IRS, card payments are reported no matter how many or how small, so for a business that takes cards, the form is an outside record of card sales.
• Sales tax returns, if the company collects sales tax.
• A list of every loan and line of credit, so you can recognize loan money when you see it.

Statements are most reliable when they come straight from the bank. Many sellers are happy to download them from online banking while you watch, or to have the bank send them to your accountant. Explain that any lender will want the same records.

How to do it, step by step

1. Add up the deposits for each month. Every account, every deposit.

2. Take out the deposits that aren't revenue. Common ones:

• Transfers between the company's own accounts
• Loan money and draws on a line of credit
• Money the owner put in
• Proceeds from selling equipment or a vehicle
• Insurance payouts, tax refunds and refunds from suppliers

3. Adjust for timing. If the company records revenue when it sends an invoice, the cash arrives later. When receivables (money customers owe) grow during the year, deposits come in a little below revenue. When receivables shrink, deposits come in a little above. Our post on reading a balance sheet explains where to find receivables.

4. Adjust for fees and sales tax. Some card processors deposit sales minus their fees. The IRS says the gross amount on a 1099-K isn't reduced for fees, refunds or discounts, so expect card deposits to run a little below it. And if the company collects sales tax, deposits include the tax while revenue usually doesn't.

5. Compare, month by month and for the whole year.

Here's how the yearly version might look if that $960,000 company were a hypothetical landscaping business:

Item	Amount
Total deposits, all accounts	$1,105,000
Less transfers from the savings account	($60,000)
Less loan money for a new truck	($45,000)
Less sale of an old mower and trailer	($8,000)
Payments from customers	$992,000
Less old invoices collected (receivables fell during the year)	($25,000)
Customer payments for this year's work	$967,000
Revenue on the books	$960,000
Difference	$7,000

A gap of $7,000 on nearly a million dollars is small and usually has an ordinary explanation. A gap of $90,000 needs a real answer.

Why month by month matters

A year can balance while the months don't. Put each month's adjusted deposits next to that month's revenue and look for patterns:

• A season that doesn't match. If the company is busiest in summer, its deposits should be too.
• Big revenue in the last month of the year, with the cash arriving months later or not at all. Revenue may have been recorded early to make the year look better.
• A gap that grows over time. That's more worrying than one odd month.

What the differences can mean

Deposits below revenue can mean:

• Revenue recorded that was never collected, perhaps because customers didn't pay, or because invoices were recorded twice or too early.
• Customer payments going into an account you haven't seen. Ask again for a list of every account.
• Revenue on the books that isn't real. It's the most serious possibility, and the main reason to check.

Deposits above revenue can mean:

• Deposits that aren't revenue and weren't identified, like an owner loan or a transfer.
• Revenue the books left out. That isn't a bonus for you. Income missing from the books may also be missing from the tax returns, and lenders work from the returns.

Small differences are normal. What you want is an explanation for every large one, backed by a document.

Cash-heavy businesses

Restaurants, car washes and salons often take a lot of cash, and cash doesn't always reach the bank. An owner might pay some bills straight from the register, or simply not deposit everything.

You may hear, "We actually take in more than the books show." Treat that as a reason to be careful, not a reason to pay more. You can't verify cash that never reached the bank, a lender won't count it, and the seller is telling you the records are incomplete. Value the company on what you can prove.

A few ways to check a cash business:

• Compare register or point of sale reports with deposits, day by day for a sample of weeks.
• Watch the mix of cash and card. The share paid in cash should be fairly steady from month to month. Card sales are easier to confirm through processor statements and 1099-K forms.
• Use the sales tax returns. In Florida, the sales and use tax return asks for gross sales, including tax-exempt sales, according to the Department of Revenue's instructions. The seller filed them with the state, so they're another record to compare.
• Visit at different times, with the owner's permission, and get a feel for how busy the place really is.

If you suspect wages or bills are being paid in cash off the books, raise it with your accountant and attorney before you go further.

The other half: money going out

The same check works for spending. Compare withdrawals and payments from the bank with the expenses on the books. It can turn up expenses that never appear in the books, like payments to a relative or a loan nobody mentioned, and expenses on the books that were never really paid. This side takes more time, and it's a good job to hand to an accountant who works on business purchases.

What to do this week

• Ask for bank statements for every account, along with revenue by month.
• Build a spreadsheet with one row per month: deposits, non-revenue deposits, adjusted deposits, revenue and the difference.
• Write down every difference you can't explain, and ask the seller about each one in writing.
• If the company takes cards, ask for its 1099-K forms and processor statements.
• Have your accountant review your work before you make a final offer.