Pre-Acquisition Audits: What Revenue Gaps Tell You

The practice looks profitable on paper. The owner says collections are strong. But when you audit the actual deposits against reported revenue, the story changes. Here is what those gaps reveal.

The Purpose of Pre-Acquisition Audits

When you are buying a dental practice, you are buying future cash flows. The purchase price is based on historical performance that supposedly predicts what you will earn going forward.

But historical performance can be misleading. Revenue might be overstated. Collections might be inflated. Problems might be hidden. The numbers on tax returns and financial statements are only as reliable as the processes that created them.

Pre-acquisition reconciliation audits verify that reported revenue actually arrived as cash in the bank. They identify gaps between what the practice claims to have collected and what can be verified. Most importantly, they reveal what those gaps mean for the true value and risk of the acquisition.

What Reconciliation Audits Examine

Bank-to-PMS Comparison

The core audit: comparing actual bank deposits to reported collections.

What you examine:

• Total deposits over audit period (typically 12-24 months)
• Total collections per PMS over same period
• Variance between the two

What you verify:

• Can every significant deposit be traced to PMS records?
• Can every significant PMS collection be traced to a deposit?
• Are there unexplained differences?

Deposit Composition Analysis

Understanding what makes up the deposits.

What you examine:

• Insurance EFT deposits (should match ERA/EOB documentation)
• Patient credit card deposits (should match merchant statements)
• Cash and check deposits (should match deposit slips)

What you verify:

• Payment type totals in PMS match corresponding deposit types
• No significant unexplained cash deposits
• Credit card deposits reconcile to processing statements

Accounts Receivable Quality

Assessing whether reported AR is collectible.

What you examine:

• AR aging distribution
• AR trends over time
• Write-off history and patterns

What you verify:

• AR is not artificially inflated
• Aging is not worsening
• Write-offs are appropriate and documented

Adjustment Analysis

Understanding how adjustments affect reported revenue.

What you examine:

• Adjustment totals by category
• Adjustment percentage of production
• Adjustment trends over time

What you verify:

• Adjustments are legitimate and documented
• No unusual adjustment patterns
• Adjustment categories make sense

Interpreting Common Gap Patterns

Gap Pattern 1: PMS Higher Than Bank

Reported collections exceed actual deposits.

Possible explanations:

Timing differences: Collections recorded in PMS but not yet deposited. Verify with subsequent deposits.

Posting errors: Payments posted to wrong dates or amounts. Review transaction detail.

Fictitious revenue: Collections recorded that never happened. Significant red flag.

Cash skimming: Cash collected but never deposited. Fraud indicator.

What to investigate:

• Can the gap be explained by specific, identifiable items?
• Does the gap persist across multiple months?
• Is there documentation supporting PMS entries?
• Are there patterns suggesting intentional manipulation?

Implication for acquisition:
If PMS consistently exceeds bank and gaps cannot be explained, reported revenue is overstated. Adjust your valuation accordingly.

Gap Pattern 2: Bank Higher Than PMS

Actual deposits exceed reported collections.

Possible explanations:

Unposted payments: Deposits received but not recorded in PMS. Operational weakness.

Non-patient revenue: Owner loans, refunds from vendors, other non-collection deposits.

Commingled accounts: Personal funds mixed with practice funds.

What to investigate:

• What are the unidentified deposits?
• Are there legitimate non-revenue explanations?
• Is the practice failing to post insurance payments?
• Are accounting practices appropriate?

Implication for acquisition:
If bank exceeds PMS due to unposted payments, actual collections may be higher than reported, but operational controls are weak. If due to commingling, accounting practices need cleanup.

Gap Pattern 3: Inconsistent Month-to-Month

Gaps vary significantly from month to month.

Possible explanations:

Poor processes: Inconsistent reconciliation means inconsistent results.

Timing volatility: Large insurance payments create lumpy timing differences.

Selective reporting: Some months cleaned up, others not.

What to investigate:

• Is there any pattern to when gaps are larger?
• Do gaps correlate with staff changes or absences?
• Were some months reconciled and others not?

Implication for acquisition:
Inconsistent gaps indicate unpredictable operations. You cannot trust any single month's numbers. Look at longer-term averages but apply higher uncertainty.

Gap Pattern 4: Growing Gaps Over Time

Variance between bank and PMS increasing over time.

Possible explanations:

Deteriorating controls: Processes breaking down.

Growing fraud: Theft scheme escalating.

Staff problems: Key person left, replacement struggling.

Intentional manipulation: Preparing practice for sale with inflated numbers.

What to investigate:

• When did the trend begin?
• Did anything change at that time?
• Is the practice aware of the trend?

Implication for acquisition:
Growing gaps are a serious warning sign. Something is getting worse, and it may continue after you buy. Require explanation and verification before proceeding.

Gap Pattern 5: Perfect Reconciliation

Bank and PMS match perfectly every month.

Possible explanations:

Excellent processes: Practice has strong financial controls. Ideal situation.

Manipulation: Numbers adjusted to match. Fabricated reconciliation.

What to investigate:

• Is reconciliation documented with source evidence?
• Can you verify the reconciliation process?
• Is it too good to be true?

Implication for acquisition:
Perfect reconciliation is good news if genuine. Verify that it is real, not manufactured for the sale.

Red Flags in Acquisition Audits

Resistance to Providing Data

Sellers reluctant to share information.

Warning signs:

• Delays in providing bank statements
• Incomplete records provided
• Excuses for missing documentation
• Hostility toward detailed questions

What it suggests: Something to hide.

Significant Unidentified Deposits

Cash in the bank that nobody can explain.

Warning signs:

• Material deposits with no PMS match
• Vague explanations for significant amounts
• Round-number deposits that seem arbitrary

What it suggests: Poor controls at best, potential fraud or money issues at worst.

Unusual Adjustment Patterns

Adjustments that do not make sense.

Warning signs:

• Adjustments spiking near year-end
• Large adjustments with vague reasons
• Adjustments concentrated with one staff member
• Round-number adjustments

What it suggests: Possible manipulation, fraud, or very poor practices.

Documentation Gaps

Missing records for significant items.

Warning signs:

• No deposit slips for cash deposits
• Missing EOBs for insurance payments
• Adjustment explanations unavailable
• Bank statements with unexplained gaps

What it suggests: Either very poor record-keeping or intentional destruction.

Lifestyle vs Income Inconsistency

Owner lifestyle that does not match reported practice income.

Warning signs:

• Expensive lifestyle with modest reported profits
• Cash purchases that seem inconsistent with distributions

What it suggests: Unreported income, which means either tax fraud (their problem becoming your problem) or cash not running through the practice (commingling concerns).

What Gaps Mean for Valuation

Adjusting EBITDA

Reconciliation gaps may require EBITDA adjustments.

If PMS overstates revenue:

• Reduce reported revenue by unexplained gap
• Recalculate collections and EBITDA
• Apply multiple to adjusted EBITDA

Example:

• Reported collections: $1,000,000
• Unexplained gap (PMS higher than bank): $50,000
• Adjusted collections: $950,000
• Impact at 5× multiple: $250,000 reduction in value

Risk Adjustments

Beyond EBITDA, gaps affect risk assessment.

Higher risk premiums for:

• Practices with unexplained gaps
• Practices with poor documentation
• Practices with inconsistent processes

Risk adjustments might include:

• Lower multiple applied
• More held in escrow
• Longer earnout periods
• Stronger indemnification provisions

Deal Structure Implications

Gaps affect how you structure the deal.

Protective measures:

• Larger escrow holdback
• Longer escrow period
• Working capital adjustments
• Specific representations about financial accuracy
• Survival period for indemnification claims

Conducting the Audit

Data Requirements

What you need from the seller:

Financial data:

• Bank statements (all accounts, 24 months)
• PMS collection reports (matching period)
• Merchant processing statements
• Deposit slips or remote deposit records

Supporting documentation:

• EOBs or ERAs for significant insurance payments
• Credit card batch reports
• Adjustment logs with explanations
• Any existing reconciliation documentation

Audit Procedures

Step 1: Summarize totals

• Total bank deposits by month
• Total PMS collections by month
• Calculate monthly and total variances

Step 2: Identify large items

• List deposits over $5,000
• List largest collection entries
• Attempt to match large items specifically

Step 3: Analyze patterns

• Graph variance over time
• Identify trends or anomalies
• Note any seasonality or patterns

Step 4: Investigate gaps

• Request explanation for significant variances
• Verify explanations with documentation
• Document what can and cannot be verified

Step 5: Assess implications

• What do findings mean for valuation?
• What risks do they indicate?
• What deal protections are warranted?

Professional Help

Consider engaging specialists.

When to engage help:

• Transactions over $1 million
• Complex situations with multiple locations
• Significant gaps that need forensic analysis
• Situations where you suspect fraud

Types of help:

• Dental-specific CPAs
• Forensic accountants
• Due diligence specialists
• Transaction advisors

Using Findings in Negotiations

Leverage Points

Audit findings create negotiation leverage.

Price adjustments:

• Reduce offer based on verified revenue
• Quantify impact of findings

Term improvements:

• Larger escrow for identified risks
• Specific indemnification for findings
• Working capital protections

Walk-away points:

• Define what findings would kill the deal
• Be prepared to walk if issues are severe

Communication Approach

How to discuss findings with sellers.

Factual presentation:

• Present data without accusation
• Ask for explanations
• Give seller opportunity to respond

Focus on verification:

• Explain what you need to verify
• Request specific documentation
• Set reasonable deadlines

Maintain relationship:

• Assume good faith until proven otherwise
• Keep tone professional
• Remember you may work with this person post-close

Conducting due diligence on a dental acquisition? Zeldent can help you quickly assess reconciliation health across practice financials. See actual bank-to-PMS matching, identify gaps, and understand what you are really buying. Schedule a demo to see how Zeldent supports acquisition analysis.