For many small business owners, ensuring that revenue and cash make sense when compared to each other is a critical exercise since cash is the most liquid account in the financial statements (which means it can be highly susceptible to theft) and revenue is often times the largest and/or one of the most important accounts to measure business performance. How does one know if all cash receipts have been properly entered into the accounting system? How does one verify that all revenues have been reported in the ledger for the period?
One such exercise can greatly help businesses to answer these questions, called a “proof of cash and revenue.” By proving out cash and revenue, businesses can get comfortable that either (1) the accounting accurately reflects all business transactions or (2) there are transactions not appropriately accounted for, triggering additional investigation.
A proof of cash and revenue exercise is rather simple, although differing degrees of complexity in a business could complicate the exercise. In essence a proof of cash and revenue exercise takes all cash receipts from an entity’s bank account statement and removes any non-revenue deposits (such as cash transfers from one bank account to another, proceeds from sale of equipment, bank account interest received, insurance reimbursements, and so forth) to arrive at what I will call “revenue deposits.”
Next, beginning-of-the-period accounts receivable, gross (make it a positive number) is netted against end-of-the-period accounts receivable, gross (make it a negative number). The result is added to revenues from the general ledger (“G/L”). The theory in adding beginning accounts receivable and subtracting ending accounts receivable is that the beginning accounts receivable is “assumed” to have been collected within the period, meanwhile the ending accounts receivable has not yet been collected, and, therefore, it will not show up in the bank account statement for the period. I will refer to this calculation as “adjusted revenue per G/L”.
The final step is to compare “revenue deposits” to “adjusted revenue per G/L” and investigate any variance that exceeds what is considered to be an acceptable variance.
When done right, this exercise can uncover errors in accounting, missing deposits, or even fraud. Although this exercise is fruitful for businesses that have standard revenue recognition practices, one can see that when customer sales exist with multiple elements, whereby “delivering” a service or a product to a customer doesn’t necessarily result in revenues (but rather some or all deferred revenue), a proof of cash and revenue is not likely to yield meaningful results.
Having said this, I’ve assisted a number of clients in performing this proof of cash and revenue analysis and clients gain valuable insight into their business practices and controls that they otherwise may not be aware of.