Silent Witness – A Forensic Accountant’s Tale

Forensic accounting is neither glamorous nor nearly suspenseful enough to rate a Friday night TV slot, however it is an exacting science in its own right and is often critical in the litigation process. Few forensic accountants have the spookily perceptive eyes of Silent Witness’ Professor Sam Ryan, however many forensic accountants would joke that their job is, like hers, about counting dead bodies.

Bad jokes aside, good detective work and accurate analysis are what it’s all about, and attention to detail can obviously make or break a case. Silent Witness turns on expert witness in the courtroom, and the analogy extends to Professor Ryan’s examining decaying bodies whilst forensic accountants examine decaying businesses and finances. But let’s skip the moonlit nights, the owls in the forests and the spooky music and get down to the fundamentals of what is a forensic accountant, when you might need one, and what to look out for in order to put your best case forward.

What is forensic accounting?

Forensic accounting is the use of investigative techniques, accounting skills and business skills to aid in the collection and formation of information to be used as evidence in court cases. As a discipline, it encompasses financial expertise, fraud knowledge, and a strong understanding of business reality and the working of the legal system.

The process includes:

o Reviewing the factual situation.

o Providing assistance in obtaining documentation necessary to support or refute a claim.

o Reviewing the relevant documentation to form an initial assessment of the case and identify areas of loss.

o Providing assistance with examination for discovery, including the formulation of questions to be asked regarding the financial evidence.

o Co-ordination with other experts.

o Reviewing the opposing expert’s damages report and reporting on both the strengths and weaknesses of the positions taken.

o Providing attendance at trial while hearing the testimony of the opposing expert and also providing assistance with the cross-examination.

Forensic accountants become involved in the assessment of economic loss damages in personal injury; assessment of damages in commercial disputes; business valuations for family law and commercial disputes; family law superannuation valuations; professional negligence claims; fraud investigation and fraud risk assessment; and business interruption claims.

When do I need a forensic accountant? As a general rule, you should get a forensic accountant involved whenever there is an issue of value that requires accounting analysis and expertise. A forensic accounting report should bring far more value to the case than its cost.

Unraveling tax planning and corporate structures Tax planning often significantly complicates an understanding of a plaintiff’s affairs. The plaintiff may be saying that he was earning $100,000 per year but his personal tax returns are only showing $20,000 per year. Most people in business will employ a number of tax planning strategies to minimise the incidence of tax. These strategies include use of corporate structures, discretionary trusts and unit trusts, superannuation, salary packaging, fringe benefits such as motor vehicles and car repayments, and splitting of income with other family members. In the assessment of damages and business valuations, it is necessary to look through the corporate entities to determine a plaintiff’s true position. The plaintiff claiming that he is earning $100,000 a year may have a $20,000 salary for himself, $20,000 for his wife, $20,000 in superannuation contributions, $20,000 in fringe benefits such as motor vehicle and personal expenses and $20,000 in profit left in the company.

Independent assessment of the issues People often have poor financial understanding either of their business itself, accounting terminology, or both. Plaintiffs will often say that they are earning, say, $100,000 per year, but they are actually referring to turnover, not profit. They have not considered the expenses incurred in operating that business.

A forensic accountant will independently examine the plaintiff’s losses or claims based on the evidence presented. They will examine the issues based on the available evidence. A forensic accountant’s investigation may include analysis of other companies associated with the plaintiff to ensure the income or expenses have not been diverted to other entities.

How to find a forensic accountant

One of the best ways to find a forensic accountant is to ask around. Ask your colleagues and other solicitors whom they use and why. Ask barristers whom they would recommend.

Forensic accounting requires a different set of skills and knowledge from general accounting. Forensic accountants will have knowledge of the rules of evidence, common law, the relevant legislation, the expert code of conduct and obligations. Forensic accountants will be experienced at giving evidence in court and preparing reports for court.

It is important to establish a relationship with the forensic accountant. An ongoing relationship enables you to ask questions about a matter and get a feeling for the issues and reduces the time required to brief the accountant. The instructions that we receive are often one page, briefly detailing the important facts of the case, contact details for the client and enclosing copies of financial documentation available. Due to our ongoing relationship with the solicitor, we arrange a conference with the client, obtain further financial details and in turn provide our expert report.

Things for lawyers to look out for

In providing critical review and analysis of other accountants’ reports, we have encountered a multitude of problems and errors. We have detailed below some of the most common errors that cause the most pain for lawyers.

Beware of one- to two-page reports

We often encounter the simple one- to two-page report valuing a business or calculating damages. These reports often have little value and can be a hindrance. The characteristics of a typical one-page report are:

o There is often little evidence to support the opinions given.

o There is insufficient detail to explain what tests or investigations have been made.

o They often do not contain the Expert Witness Code of Conduct.

o They often have significant errors in methodology.

o The opinions put forward often crumble under critical investigation and examination.

o Initial opinions and views are often changed following a more detailed examination of the issues.

Beware of complex financial models

Often forensic accountants will develop complex financial models of a business to illustrate the effects of an event of damage (personal injury, breach of contract, fire etc). Upon initial examination, these models will often appear to be well argued and considered. Complex models often have assumptions based on other assumptions and it is often only necessary to attack one or two assumptions based on logic or common sense and the model will show losses rather than profits. The more complex the model, the easier it is to discredit.

In one case, the plaintiff’s accountant developed a complex model showing the expected earnings and actual post damage earnings in a wholesaling company. The company showed a significant decline in turnover and profits in the month, post-accident. The company subsequently recovered from its damage. The plaintiff’s solicitors also allocated considerable resources to the case on the basis of the expected losses as detailed in the accountant’s report. We were able to show that the loss was the result of a loss of a major client that happened pre-damage. The massive losses put forward by the accountant were significantly reduced and the report was discredited.

Complex financial models will often produce results that deliver unexpected large damages claims. In the calculation of damages, there is a simple test that can be applied. Add the loss to post-damage earnings and compare to pre-damage earnings. If there is a significant difference, then the reasons need to be explained. A good, experienced forensic accountant should be able to show a number of different ways to approach a problem. The simplest approach is often the best. A simple approach often examines the real drivers of the business and the principles are more easily understood by all.

Ask where the weaknesses are

Every report will have some weaknesses. The weakness might be minor or significant. Ask the forensic accountant where the weakness is in the report. The accountant should know where the weaknesses are, which assumptions are solid and are supported by evidence and which will be susceptible to critical examination. Examples include basing earnings on one year’s trading or three to four years’ trading. The accountant may reason: “There is an argument that gross profit should be based on the average of the last three years, which would reduce the claim, but the recent changes in the product mix support using the most current data,” or “The evidence supporting this assumption is poor and will be dependent upon the plaintiff’s testimony.”

Get accountants involved early

In many instances we get involved too late. Damages may be assumed to be significant and legal resources are allocated accordingly, only to find that the actual damages are minimal and the opportunity to recover a settlement or verdict in excess of the legal fees is impossible. Getting forensic accountants involved early will also give the accountant the opportunity to request further information and gather evidence such as witness statements and property valuations.

Check for mathematical accuracy

Always ask the accountant if the mathematical accuracy of the report has been checked. A mathematical error can substantially affect the credibility of the report and the plaintiff’s claim. We were asked to assess a personal injury claim for a professional footballer. The accountant’s report for the plaintiff was well argued and the plaintiff’s earnings were supported by leading coaches and agents. Whilst the question of probability is always an issue for professional sports people, the quality of statements and testimony of the coaches and agents may have outweighed any statistical analysis of probability. We carried out a simple check of the mathematics of the report and found that the plaintiff’s gross loss rather than net loss was used to calculate future loss. The claim for future economic loss was halved. A simple independent check of the mathematical accuracy with a calculator by the accountant for the plaintiff would have prevented this error.

Reports should be readable first time

A forensic accountant’s report should be able to be understood and absorbed on the first reading. If you have to read a report three or four times before you can understand what it is trying to say, judges and counsel will have the same problem. A good report will contain an executive summary that introduces all the major issues and states the conclusions so that the reader will understand the direction and focus of the report. A business valuation that explains in the executive summary the total valuation, the basis of valuation used, the main assumptions in that valuation (such as capitalisation rate and future maintainable earnings) and a brief explanation of the important factors behind the assumptions will provide an excellent introduction to the report.

Forensic accountants provide a valuable resource for the solicitor in litigation. The investigative and analytical ability to examine financial and business matters complements the legal skills of solicitors. Maybe one day there will be a gripping, suspenseful TV show about forensic accountants. Maybe not.

What Separates the Good Business Broker From the Bad?

Over the years, I’ve heard a million horror stories from business owners about their experiences with some of the “fly by night” business brokers out there. It’s always the same names and it always makes me wonder, “How did you get hooked up with these people? Why did you hire them?” I mean, I’ve seen some of their work and it’s TERRIBLE!

So, of course I feel bad for the business owner and I begin to question my ability to market my business brokerage services. If only I had been there first. If only these folks knew to call me or one of the other good credible brokers out there rather than the yahoo they ended up using. Yes, you heard me right; there are a lot of good credible business brokers out there. The problem is, there are a lot of bad, unqualified brokers out there as well. I’m in the business so it’s easy for me to tell the difference. But how can you, as the business owner, tell the difference?

Well, that’s a tough question to answer but I’ve been giving it some from thought and I’ve decided that the most important factors that separate the good business brokers from the bad are:

1. Ethics – most horror stories I hear are a result of a lack of ethics by the broker. This is unfortunate and disgraceful in my opinion. Unfortunately, there’s no easy way to test a broker’s ethics. My best recommendation is to make sure they’ve achieved their CBI (Certified Business Intermediary) designation from the IBBA (International Business Brokers Association). All CBI’s agree to adhere to the IBBA’s Standards of Professional Conduct and the Code of Ethics. I know acceptance of a code doesn’t guarantee anything, but it’s a good start. The second thing I would recommend is to check references. This can be tricky. Like any good job applicant, when you ask for references you will get handed the happiest and most satisfied clients that the broker is confident will put in a good word. So, to me this is a waste of time. Instead, why not call the other professionals in your area. It takes more than just the broker to do a deal. It’s takes an accountant and attorney as well. Call your accountant, have your friends call their accountants, same with your attorney and their attorneys. Not all accountants and attorneys will be close to the transaction marketplace (they tend to specialize) but they will ask around. Chances are they probably work with, know of, or went to school with another accountant or attorney that is involved in transactions. If you’re willing to put some time into checking credentials, sooner or later you will find your answers.

2. Candor / Honesty – Again, this can be difficult to judge for the untrained eye. But, what does your gut tell you? Are you receiving vague answers to your questions? Or, is the business broker you’re interviewing willing to sit down with you and answer every question that you have to the best of their ability, sometimes going above and beyond? If this is the case, usually it’s because they have nothing to hide. And, as a result, don’t have to tiptoe around your questions.

3. Pricing Ability – Being open, honest and ethical is only part of the game. It’s equally as important that the business broker be educated on matters of business valuation. One of the most important factors in selling a business is pricing it right. A mispriced business will either never sell (if overpriced) or fly off the market (if underpriced). Both situations are bad news for you as the business seller. If it’s overpriced it will sit on the market, get stigmatized and be difficult to sell even with a different broker. If it’s underpriced you will not maximize your retirement money. Make sure you ask the business broker you are interviewing if they know how to price a business. Moreover, make them prove it. Ask them to explain the three different approaches to value (Asset, Income and Market). If they don’t know what you’re talking about, RUN!! Ask for samples of the broker’s pricing analyses. Don’t settle for a broker that answers, “I can’t provide that it’s confidential”. Every broker can cleanse some samples and make them generic. Take them home. Review them, see if you would buy the business they present to you. Show it to your accountant and your attorney. Get their thoughts. If you’re not sure whether you’re looking at quality work or not, chances are your accountant or attorney will.

4. Marketing Ability – Remember at the end of the day, your small business is a non-marketable entity. You can’t go online, click a button and get rid of it. Someone has to actively create a market for your business. Ask the broker you are interviewing, “How do you plan to market my business?” Sit back and listen. If all they say is, “I’m going to post it on the internet,” RUN!! You can post it on the internet. For the fee the broker is taking, make sure they’re adding value. Dig deep on this subject. You won’t need to be a marketing guru to determine if the broker has a developed process that works.

5. Reputation – Part of investigating the reputation of the broker is requesting references. Not only client references but asking around for input and insight from other professionals about what business brokers they know and what they know about them. Also, go to the broker’s website; go to industry sites such as http://www.ibba.org. Look up the broker; see what other people are saying about them. Do the TV, newspaper, radio and trade publications value the broker’s opinion? It’s not easy to get quoted in articles, written about in papers, invited to be a guest on TV or radio shows. Professional media outlets do their homework. They can’t afford to put their name next to a non-credible source. A business broker that is taken serious and considered a credible source by mainstream media deserves consideration. Credibility is not bought, it is earned.

6. Courtesy / People Skills – Take the time to interview the broker in person. Never hire a business broker without meeting them. If they’re not willing to take the time to meet with you, chances are they won’t put much effort into selling your business either. Once they’re in front of you, see how they interact with you. Are they personable? Do you trust them? Are they friendly? Are they educated about your business and the business brokerage industry? Make no mistake, this is a people business. People buy from people they like. If you don’t like the person you’re interviewing, chances are neither will a potential buyer for your business.

7. Education / Experience – Business brokers are professional service providers, like accountants, attorney, financial planners, etc. Make sure the person you hire to sell your business (or help you buy one) continually invests in their own education and professional development. Would you hire an attorney that doesn’t keep up with current laws? Would you hire an account that isn’t updated on the tax code? Your business is the largest and most valuable asset that you own. Make sure the person you hire to turn it into cash is someone that stays current on industry trends, government regulations, new pricing methodologies, marketing strategies, etc. Business brokerage is a full time profession. If your broker doesn’t invest in their own professional development, chances are there’s someone else out there that does and will do a better job at selling your business for the highest possible price.

The suggestions above are not fool proof but, they will get you pointed in the right direction. Don’t take the sale of your business lightly. Make sure you do your homework. If you do, the wheat will quickly separate from the chaff.

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