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The Value of Proof of Cash in M&A Transactions

A proof of cash focuses on cash basis revenue and EBITDA to try to ground financial statements with a third-party source document. Read on for more.
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In a mergers and acquisitions (M&A) transaction, potential buyers will evaluate a multitude of financial and other trends, metrics, and statistics. However, many of them often lead back to the same spot: recurring free cash flow. As we will examine, financial due diligence may look different for audited versus unaudited companies, and an analysis often used with unaudited companies is a reconciliation of the cash flows suggested by a company’s financial statements to its bank statements. While this cash flow reconciliation is not a substitute for traditional financial diligence, it is frequently used to enhance financial diligence in unaudited companies where internal controls and financial statement policies may not be as formalized.  

Purchase Price Overview

Purchase price often garners the most interest in an M&A transaction, and the purchase price often consists of (i) base purchase price, (ii) plus cash, to the extent it is acquired, (iii) minus indebtedness and transaction expenses, (iv) plus or minus a working capital adjustment. This excludes consideration for other holdbacks and escrow funds. With regard to the base purchase price, private buyers and sellers have often agreed to an adjusted revenue and/or EBITDA (earnings before interest, taxes, depreciation, and amortization) level and an implied multiple in the letter of intent.

Diligence Regarding Adjusted Revenue & EBITDA

Buyers want to gain comfort regarding both the accuracy of reported revenue and EBITDA, as well as adjustments for nonrecurring, noncash, or out-of-period items. If a target company is audited, recent audit workpapers are typically read to understand what work was performed regarding the historical financial statements. If a target company is not audited, formal internal controls do not always exist and supplemental diligence procedures may be completed, one of which is a proof of cash.

What Is a Proof of Cash?

In a basic form, a proof of cash is a reconciliation of the cash flows suggested by a company’s financial statements to its bank statements.

From a revenue and EBITDA perspective, buyers may initially focus on the income statement. If the income statement is maintained on an accrual basis, accrual basis revenue and EBITDA need to be converted to cash basis revenue and EBITDA for comparison to the bank statements. This is done by “unwinding” the changes in operating assets and liabilities (accounts receivable (AR), inventory, accounts payable, etc.) For example, if revenues in a month were $5 million and AR increased $1 million during that month, cash collected from customers in that month would be expected to be $4 million.

The next step for a buyer is to analyze the cash deposits in the month and compare to the $4 million of expected customer receipts. If cash deposits in the bank statements are less than $4 million, further inquiry is needed. If cash deposits in the bank statements are more than $4 million, additional investigation of the cash deposits is needed. For example, did the company borrow any debt, sell any fixed assets, make a deposit from another account through a transfer, or receive any equity contributions? Those also would need to be adjusted as part of the reconciliation.
A similar process is completed for expenses, adjusting for changes in inventory, accounts payable, etc., and comparing to cash disbursements per the bank statements.

What Can a Proof of Cash Tell You?

The primary result of a proof of cash is feedback on whether cash basis revenues and cash basis expenses can be reconciled to the company’s bank statements, which may provide a buyer comfort that reported financial statements can be traced to third-party source documents, i.e., bank statements. In addition, a proof of cash identifies unusual transactions to be analyzed further.

What Does a Proof of Cash Not Tell You?

There are many things a proof of cash alone cannot tell you, including whether the reported accrual basis revenue and EBITDA are correct or whether fraud exists. Recall that a proof of cash focuses on cash basis revenue and EBITDA.

Once the proof of cash is completed, it may be helpful to compare cash basis revenue and EBITDA to accrual basis revenue and EBITDA. If accrual basis revenue and EBITDA are significantly higher than cash basis revenue and EBITDA, additional analysis of the factors causing the difference may be warranted. In our previous example, AR increased $1 million, which would result in accrual basis revenue and EBITDA being $1 million higher than cash basis revenue and EBITDA (excluding all other changes). If this $1 million change is significant to the overall valuation, concepts such as AR aging, AR allowance reserves, and collectability of outstanding receivables would be further evaluated. Similar analysis would be completed for prepaid expenses, inventory, accounts payable, accrued expenses, etc.

A proof of cash is not a substitute for detailed financial diligence. It is a supplement to it and is designed to provide reconciliation to third-party source documents and point the buyer to potential large differences between cash basis revenue and EBITDA/accrual basis revenue and EBITDA that should be further analyzed.

A proof of cash is typically completed for unaudited companies and also could be completed for audited companies if a significant amount of the last twelve months (LTM) in the diligence period has not been audited. For example, a diligence project being completed late in 2023 may have an audit through December 2022, but 10 of the 12 months in the LTM would be unaudited. 

What Complexities May Be Encountered in a Proof of Cash?

One item that can cause significant complexities in a proof of cash is bank transfers between accounts. If there are only two accounts and transfers are relatively straightforward to identify on the bank statements, this may not require extensive extra attention. However, if there are multiple bank accounts across several entities, some of which are in foreign currencies, isolating the impact of bank transfers may be more cumbersome. Since transfers represent cash inflows and outflows in the bank statements but represent neither revenues nor expenses on the income statement, they are a reconciling item that must be identified to fully reconcile revenues to cash receipts and expenses to cash disbursements. 

Since a proof of cash “assumes” standard journal entry relationships, unusual journal entries are another item that can cause complexities. In our previous example, revenues plus or minus the change in AR equals expected customer receipts. However, if the company recorded an unusual journal entry to debit cost of goods sold and credit AR, this would cause a difference in both the proof of revenues and the proof of expenses (with an offsetting impact). These nonstandard journal entries may result from the company having unsophisticated financial reporting teams, systems, and/or processes, or they may have experienced turnover in the positions responsible for financial reporting. Whatever the reason, if you were expecting $4 million of customer receipts and instead identified only $3 million, these types of journal entries may be a partial cause of the difference.

In addition to unusual journal entries, there are certain general ledger accounts that do not only move with revenues or expenses. One example is a sales tax payable, where a company may have both inflows (sales tax received from a customer) and outflows (sales tax paid to the government) without a change in net revenues or expenses in the income statement.

If you have addressed the items above and still have a difference, it may warrant a rollforward of nonworking capital accounts. One example is when depreciation expense (a noncash expense that does not impact the proof of cash) does not roll the accumulated depreciation balance. We have previously mentioned other accounts such as debt and equity that need to be rolled to separate cash inflows from cash outflows.

Finally, the proof of cash may reconcile on a net basis (cash basis net income agrees to the net cash flows from the bank statements) but may have a significant difference on a gross basis (cash basis revenue may not agree to cash deposits on the bank statements). Buyers may want to further reconcile differences in revenues and expenses on a gross basis because an add-on transaction may have a focus on revenues or help validate an investment thesis around cost synergies or margins. However, at the same time, there is a cost/benefit decision to be made regarding how large of a variance on a gross basis is acceptable.


A proof of cash is a supplemental due diligence exercise that focuses on cash basis revenue and EBITDA in an effort to ground the financial statements with a third-party source document. Additional analysis is warranted for large differences between cash basis EBITDA and cash inflows/outflows per the financial statements, as well as between cash basis revenue and EBITDA and accrual basis revenue and EBITDA.

If you have questions or need assistance, please reach out to a professional at Forvis Mazars or submit the Contact Us form below.

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