Glossary
Proof of Cash: How the Reconciliation Works and What It Establishes
A proof of cash reconciles a company’s bank activity to its accounting records across a whole period, matching total receipts and total disbursements separately. It tests whether the cash movement implied by the financial statements actually happened.
In our quality of earnings work we start here, before the earnings analysis. The reasoning is sequential: an adjusted earnings figure is built on the financial statements, so the statements have to hold together first.
How it differs from a bank reconciliation
A month-end bank reconciliation answers a narrow question: does the closing bank balance agree to the books on that date?
It can agree perfectly while unrecorded receipts and unrecorded payments offset each other. A proof of cash is wider, because it reconciles the totals flowing in and the totals flowing out across the full period rather than a single balance at a single date.
The underlying logic
The test is easier to follow as two propositions rather than as a schedule.
Receipts. Bridge revenue to bank receipts using relevant balance-sheet movements and other reconciling items. Receivables are one part of that bridge. Depending on the business, customer deposits, deferred revenue, sales taxes and other items may also matter. Investigate unexplained differences.
Disbursements. Bridge operating expenses and cost of sales to payments using non-cash adjustments and relevant movements in payables, accruals, prepayments, inventory and other accounts. Identify financing, capital spending and other non-operating flows separately. The schedule depends on the business; this is not a complete formula for every engagement.
The two sides are kept separate deliberately. Netting them reintroduces the exact weakness of the balance-level reconciliation.
What has to come out of the bank data
We review bank movements to identify amounts that should be reconciled separately from operating activity. Categories discussed in our transaction work include:
- Transfers between the company’s own accounts. Operating, payroll and reserve accounts move money between themselves, and every leg would otherwise be counted.
- Line of credit draws and repayments. Repaying a facility is not an expense.
- Shareholder distributions. Cash out, but not an operating cost.
- Tax payments that do not sit in operating expenses.
- Capital expenditure, which is cash out against the balance sheet rather than the income statement.
Removing these is most of the work on the disbursements side, and it is where an incomplete removal quietly produces a variance that looks like a problem in the books.
Choosing the period
The default is the same periods as the wider analysis, so the cash picture lines up with the earnings picture.
Where a business changed accounting system partway through, general ledger history may sit in two systems. One possible response is to test a continuous twelve-month window within one system. That changes the period tested, so agree and disclose the coverage and any gaps. It does not establish that the omitted period reconciles.
Reading the result
| Outcome | What it establishes | What it does not establish |
|---|---|---|
| Both sides reconcile within tolerance | Recorded activity is consistent with third-party bank data for the period tested | That earnings are correctly stated, or that adjustments proposed by a seller are supportable |
| A difference outside tolerance | Something needs explaining before the earnings work proceeds | That the records are wrong, or that anyone acted improperly |
| A difference explained by a system change or an unrecorded receipt | The reconciliation can be completed once corrected | That similar issues do not exist elsewhere in the records |
| Underlying balances are themselves unreliable | The test is weakened, because the receivable and payable movements feed the calculation | That the reconciliation is meaningless, only that its precision is limited |
Agree investigation thresholds for the engagement in light of the amounts, nature of the differences and purpose of the work. A percentage alone is not a standard of accuracy or a pass mark. A small net difference can contain material offsetting items.
A difference is a prompt, not a finding. Our review discussions include system changes and receipts missing from the financial records as possible explanations. Test each explanation rather than assuming it resolves the difference or rules out a wider issue.
Where it sits in the work
A proof of cash is a reconciliation. It is not, on its own, the part of diligence that changes a price.
It sits alongside general ledger and tax-to-financial-statement reconciliations. These procedures test consistency and identify differences within their scope; they do not establish the accuracy of all financial information. Findings and unresolved items inform the adjusted EBITDA analysis and proposed normalization adjustments.
Its value to a buyer is that it works from third-party bank data rather than from the company’s own ledger, which is also why it is a reasonable first step for someone assessing a small, straightforward business before commissioning wider work.
Frequently asked questions
What is a proof of cash in simple terms?
A check that the money the accounts say moved is the money the bank says moved, over a whole period, with receipts and payments tested separately.
Is a proof of cash required in every deal?
The required procedures depend on the engagement scope and intended users. Discuss the purpose, available records, periods and limitations with the provider. Electronic payment records can assist the work but do not, by themselves, establish the scope required.
Does a proof of cash detect fraud?
It is not a fraud examination and provides no assurance. It can surface differences that warrant a closer look, such as a gap between recorded and banked revenue or a disbursement with no operating purpose. What those differences mean is a separate question.
What is an acceptable variance?
There is no universal percentage that makes a reconciliation acceptable. Ask how thresholds are chosen, how individual differences are investigated and how unresolved items will be reported. Consider both amount and nature.
How far back does it go?
Usually the same periods as the wider analysis, typically the two prior fiscal years and a trailing twelve months. Where an accounting system changed mid-period, a clean twelve-month window inside a single system may be used instead.
Does Treewalk audit the bank records?
No. Treewalk does not provide audit or assurance services. A proof of cash performed within a quality of earnings engagement is an advisory procedure, and its report is not an audit opinion.
Where to next
For the wider process this sits inside, read the quality of earnings report entry. For what happens to the earnings figure afterwards, read EBITDA and EBITDA normalization adjustments.
To discuss diligence on a specific transaction, contact our transaction advisory team.
Treewalk, Chartered Professional Accountants, provides advisory services.
