When people think of forensic accounting, they often think of fraud investigations. The skill set, however, covers a much broader field.
The American Institute of Certified Public Accountants defines forensic accounting on its website as generally involving “the application of specialized knowledge and investigative skills possessed by CPAs to collect, analyze, and evaluate evidential matter and to interpret and communicate findings in the courtroom, boardroom, or other legal or administrative venue.” There are other credentials and certifications in addition to CPAs that professionals may obtain in the course of specializing in forensic accounting.
Privately held businesses most often encounter the use of forensic accounting services in valuation of their enterprise when contemplating a sale, transfer or inheritance, or in post-acquisition disputes.
Owners sometimes hold a general idea of what they think their business is worth, but unless they find a buyer willing to pay the price they have in mind, it is advisable to obtain an objective valuation that is supported by appropriate evidence. Forensic accounting is used to gather data about the business and its operation, industry, potential for growth, and ability to generate positive cash flows and a return on invested funds.
Forensic accountants also look at the competitive environment, what barriers to entry may exist, potential risks of technological disruption, and any other relevant facts and circumstances. Owners, who reinvest in their business to stay on the forefront of their industry, may be able to obtain higher valuations than those who use all the cash flows generated for compensation to support a more lavish lifestyle.
When and how cash generated by the business is used will impact its value. If assets are not used to optimize the operation of the company, it may be more valuable to liquidate and sell the equipment than to continue running it, since the return on investment may be inadequate to generate sufficient cash flows to provide adequate return on the investment.
Industry trends may also play a role in valuations. Fields considered fragmented – where many small, private operations are prevalent – will over time attract larger, often public, companies that consolidate such businesses. They may offer exiting owners potential prices that appear to include premiums.
However, the terms may not involve up-front cash payments of the full price, but rather include continued involvement of the owner, and contingent amounts that may be paid over time if certain targets are met. In such situations, it is advisable to consult a CPA to help evaluate an offer and present alternatives in an objective format that helps the business owner make informed decisions.
Entrepreneurs generally start businesses because they identify a need that they can meet and make money doing it. But there is another trait they share: they prefer to be in control.
When presented with an opportunity to sell at what appears to be an attractive price, if the sale involves their continued involvement under new ownership, and requires meeting specified targets, part of the decision-making process should be to decide whether the criteria are reasonable and are they receiving sufficient compensation for giving up control. Forensic accounting can aid in that process.
Alternatively, if the seller provides part of the financing for the buyer, but does not continue working past the transition, and then the business does not perform as expected under the new ownership and the new owner does not make the agreed upon payments, then forensic accounting is necessary to establish economic damages and assist the seller in recovery from the situation.
These are only a few of the ways forensic accountants serve entrepreneurs. Owners should consult with their CPAs to seek appropriate advice before any such situations are encountered.
Ibolya Balog is a consultant with Asterion Inc., a firm that provides economic and financial consulting services in the Philadelphia area. Balog, an Allentown resident, is chair of the Pennsylvania Institute of Certified Public Accountants’ Pennsylvania CPA Journal editorial board.