Cut-off testing, explained simply
Around period end, revenue can be recorded early and costs recorded late, improving the period. Diligence examines transactions in the days either side of the period end and traces each to delivery and receipt documents.
Cut-off errors do not change total profit over time. They change which period the profit falls in, which matters for the trend, the LTM figure and the closing balance sheet.
Transactions around the 2025 year end
IllustrativeAlder Creek Manufacturing
Both items were recorded in the wrong period and reduce FY2025 EBITDA by $0.28 million in total.
Procedure
- Select sales invoices from the last and first 10 to 15 days around the period end.
- Match each to delivery or shipping documents.
- Select supplier invoices and payments received after the period end.
- Determine whether they relate to goods or services received before it.
- Move misplaced items to the correct period.
Worked example
| Alder Creek, December 2025 year end | Effect on FY2025 EBITDA ($m) |
|---|---|
| $0.4m order invoiced in December, shipped 5 January (profit at 33% margin) | (0.13) |
| December freight and utility bills recorded in January | (0.15) |
| Total cut-off adjustment | (0.28) |
Alder Creek Manufacturing, Inc. is a fictional company. All figures are illustrative.
Why it matters in a deal
Cut-off errors move profit between periods, distorting trends, the LTM figure and the closing balance sheet. Errors just before a sale need particular attention.
Red flags
- Unusually high sales in the last days of a period
- Many credit notes issued just after period end
- Large supplier invoices dated after period end for earlier services