How do I verify a small business's revenue before buying it?

By reconciling the money that arrived in the bank to the revenue on the income statement and the revenue on the tax return, period by period. The procedure is called a proof of cash, and SBA now requires it on larger acquisitions.

Under SOP 50 10 8.1, a quality of earnings report on an acquisition at or above a $3 million business purchase price must include a cash proof, which SBA defines as a financial analysis reconstructing cash receipts and disbursements by reconciling bank statement data to the income statement and tax return for each period under review. SBA states its purpose directly: to identify discrepancies in income and undisclosed expenses. It runs over the trailing twelve months and the last two fiscal years, with reduced scope if the business is younger than two years.

Below that threshold nothing requires it. The procedure is the same either way.

What you are comparing

Pull five records for the same periods: bank statements, the general ledger or accounting file, merchant processor settlement reports, point-of-sale or invoicing records, and the filed tax returns.

Then reconcile deposits to reported revenue. The two will not match, and the reasons they do not match are the point of the exercise.

The differences that are supposed to be there

Merchant settlements arrive net of processing fees, so card revenue lands lower in the bank than on the invoice. Deposits land a day or more after the sale, which shifts amounts across period boundaries. Sales tax collected is in the deposit and is not revenue. Refunds and chargebacks reduce deposits after the original sale. On accrual books, revenue is recorded when earned rather than when collected, so receivables and deferred revenue separate the two figures by design. Owner contributions, loan proceeds and transfers between accounts are deposits that are not sales at all.

The differences that are not

Once the explainable items are accounted for, a residual gap is a finding. Deposits materially below reported revenue suggests revenue recorded that was never collected, or never existed. Deposits materially above reported revenue suggests income that did not reach the books, which is sometimes presented as a selling point and is a problem: it is not verifiable, a lender will not lend against it, and a seller willing to understate income to the tax authority is telling you something about the records generally.

Cash-heavy businesses need the deposit pattern itself examined, not just the totals.

What a gap is worth

An unexplained difference is not automatically a reason to walk. It is a reason to ask for the next document, and to size the exposure. A reconciliation difference that persists across both fiscal years and the trailing twelve months, on the same line, is a different matter from a one-month timing break.

What it should never do is pass unexamined into the earnings figure you pay a multiple on.

Considering a business purchase? BankableDeal can help review the earnings, add backs, and working capital behind the deal.