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‘Rules of Thumb’ Can Leave You ‘All Thumbs’ In Most Business Valuations

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of forensic accounting services including business valuation, fraud investigation, and fraud deterrence programs in Philadelphia and the Delaware Valley.

Some trade associations and business brokers, among others, use what are called Rules of Thumb to explain to business owners the “value” of their company. While this may provide some general ballpark approximations of worth, Philadelphia forensic accountant and Certified Valuation Analyst David Anderson said there are many problems with relying on this general principle that could be generally close but not completely reliable or accurate.

Anderson – principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of business valuation services in the Delaware Valley – explains there can be significant differences between the value developed using a Rule of Thumb and the value determined by a qualified professional business valuator using professional valuation standards.

In the context of business valuation, Rules of Thumb are theoretical units of comparison.  They usually are expressed as a range of multiples of either sales or SDE (seller’s discretionary earnings, which equal the total of owner’s compensation and net profit).  For example, a Rule of Thumb for a certain industry may be that a business is worth 1.1 to 3.8 times sales or 3.5 to 6.4 times SDE.

Rules of Thumb generally presume the business being valued is an average business.  They may be based upon transactions that represent the sale of the assets of a business or, instead, that represent the sale of the equity of a business.  Anderson – a forensic accounting expert in Philadelphia with experience conducting business valuation services in the Delaware Valley – said Rules of Thumb also may be based – in some cases – on the presumption the business buyer is paying 100 percent of the purchase price in cash or – in other cases – on the presumption the business buyer is paying a combination of cash and debt or cash and a percentage of future earnings.

Unfortunately, most Rules of Thumb (including those in many business reference guides) provide limited information, if any, regarding the specifics of the underlying transactions which gave rise to the Rule of Thumb ranges.  Accordingly, Anderson, a Certified Valuation Analyst in Philadelphia, said such Rules fail to recognize differences in profitability, business lines, customer concentration, capital structure, management, geographic location, and other important factors. Furthermore, local Rules of Thumb may differ from national Rules of Thumb.

Given the shortcomings of Rules of Thumb, most professional business valuation standards discourage using Rules of Thumb.  For example:

  • NACVA (the National Association of Certified Valuators and Analysts) professional standards state “Rules of Thumb are acceptable as reasonableness checks, but should not be used as a standalone method.”
  • AICPA (the American Institute of Certified Public Accountants) professional standards state “A Rule of Thumb is typically a reasonableness check against other methods used and should generally not be used as the only method to estimate the value of the subject interest.”
  • ASA (the American Society of Appraisers) professional standards state “Rules of Thumb may provide insight into the value of a business, ownership interest, security or intangible asset. However, value indications derived from the use of Rules of Thumb should not be given substantial weight unless they are supported by other valuation methods and it can be established that knowledgeable buyers and sellers place substantial reliance on them.”

Similarly, the courts rarely accept Rules of Thumb as a valuation method. Anderson, principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of business valuation services in the Delaware Valley, cited a case addressing this issue was In re:  Marriage of Hagar – 2010 WL 4807559 (Iowa App.) (Nov. 24, 2010).  In this case, a divorcing couple in Iowa had a disagreement regarding the value of a jointly owned dry cleaning business.  The husband’s expert made four “calculations” of the value of the business ranging from negative $120,000 to positive $79,329.   The expert testified:

“… this is not a valuation.  This was a computation utilizing Rules of Thumb that are documented as industry standards but not using the judgment, simply using calculations following each of four suggested formulas”

Furthermore, on appeal, the wife pointed out the husband’s expert’s use of Rules of Thumb and industry standards did not require the same professional judgment as a complete valuation.  In this matter, Anderson, a Certified Valuation Analyst in Philadelphia, said the appeals court rejected the husband’s expert for not using judgment and using Rules of Thumb instead of issuing a professional opinion of value.

Rules of Thumb can be useful for obtaining a ballpark range of value for a business.  However, a professional business valuation is necessary if the value of a business needs to be determined in any of the following situations:

  • Divorces
  • Shareholder Disputes
  • Economic Damages Calculations
  • Litigation
  • Tax Matters Such as Gift Taxes and Estate Taxes
  • Accounting Compliance Matters (For Audits) Regarding Goodwill Impairment; Purchase Price Allocation; And Other Fair Value Measurements
  • Sale, Purchase or Merger of a Business

If you require the services of a Certified Valuation Analyst in Philadelphia or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson is a forensic accounting expert in Philadelphia who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Valuation Analyst and a Certified Fraud Examiner in Philadelphia.

Forensic Accountants Help Fight Fraudulent Conveyance Litigation

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, fraud deterrence, litigation support and expert witness testimony services in Philadelphia and the Delaware Valley.

Facing losses from such occurrences as foreclosures, divorces and other legal proceedings, shady business owners sometimes resort to the fraudulent conveyance or transfer of property or other assets to lessen or eliminate their losses by hiding valuable assets.

When that happens, it is the role of the forensic accountant to uncover the improperly transferred assets and determine their value.

“Black’s Law Dictionary defines fraudulent conveyance or fraudulent transfer as ‘the illegal transfer of property by a debtor to avoid creditors or claims’,” said David Anderson, principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides litigation support services and expert witness testimony in Philadelphia and the Delaware Valley. “It is a blatant action intended to undermine often legitimate claims filed by creditors, ex-spouses and other parties.

Anderson said the resulting fraudulent conveyance litigation typically involves civil suits bought by creditors or bankruptcy trustees seeking to recover improperly transferred assets or business. Examples of these transfers include:

  • Payments to related parties, including other businesses in which the debtor has an ownership interest, and relatives, friends or business partners of the debtor;
  • Transfer of title of assets from the debtor to related parties, including other businesses in which the debtor has an ownership interest, and relatives, friends or business partners of the debtor;
  • Sales of assets at bargain prices from the debtor to related parties, including other businesses in which the debtor has an ownership interest, and relatives, friends or business partners of the debtor;
  • Transfer of business (sales) to other entities in which the debtor or relatives, friends or business partners of the debtor have an ownership interest; and
  • Gifts made by the debtor during a period of financial stress, including donations to charity.

In cases of fraudulent conveyance litigation, attorneys rely on forensic accountants to document the alleged fraudulent transfer; identify and locate improperly transferred assets and calculate the lost value of improperly transferred assets or business, said Anderson, a Philadelphia forensic accountant who also is a Certified Fraud Examiner in Philadelphia.

Anderson, a forensic accounting expert in Philadelphia and the Delaware Valley who has performed forensic work in multiple fraudulent conveyance matters, recalled one such case that later became the basis for his case study, “The Sore Losers.”

He said the case involved business owners who wanted to avoid a creditor’s foreclosure action by draining funds from the company. Anderson, whose full range of forensic accounting services in Philadelphia and the Delaware Valley includes litigation support services and expert witness testimony in Philadelphia, said the business owners improperly paid themselves special bonuses and distributions, drastically increased rents charged to the business on real estate owned separately by the business owners, and ran personal expenses through the company. Anderson, a Philadelphia forensic accountant who also is a Certified Fraud Examiner in Philadelphia, was able to identify each of the transactions and calculate the total amount of the payments, thereby facilitating the creditor’s recovery of the payments.

Anderson, a forensic accounting expert in Philadelphia whose company offers a full range of forensic accounting services in Philadelphia and the Delaware Valley, recalled another case in which a husband who planned to divorce his wife sought to reduce the value of his business so as to decrease the amount of his future divorce settlement.

The husband sold certain assets to his girlfriend at a bargain price and also had a friend set up a competing business, to which the husband directed his own customers. After the divorce was completed, the plan was to have the friend sell a majority interest in the new business to the husband at a bargain price, according to Anderson, a Philadelphia forensic accountant.

The fraudulent transactions were discovered after Anderson was engaged by the wife’s counsel to value the husband’s business. “During my investigation, I noted a significant decline in the business as well as the sale of certain assets during the two years preceding the divorce,” he said. “The investigation revealed the transfer schemes, and I was able to value the husband’s business as if these improper transfers had never occurred, thereby increasing the divorce settlement paid to the wife.”

If you are in need of litigation support services or expert witness testimony in Philadelphia, or require the services of a forensic accounting expert in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley. The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services. Company principal David Anderson is a forensic accounting expert in Philadelphia who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Valuation Analyst and a Certified Fraud Examiner in Philadelphia. Anderson also has provided expert witness testimony in the Greater Philadelphia area and served as a forensic accounting consultant on both civil and criminal cases.

Leave No Stone Unturned in Your Search for Fraud

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, fraud deterrence, litigation support and expert witness testimony services in Philadelphia and the Delaware Valley.

The Director of Operations at a large national financial services firm did such a good job reducing costs during a recent business downturn that his company saw savings of $50,000 a year.

However, as part of that expenditure reduction, the Director pocketed $100,000 a year for himself.

“The fraud perpetrated by this trusted employee was ingenious in that the very program he initiated to save the company money was, in fact, the same program that allowed him to siphon a significant amount of money out of the company and into his own hands,” said David Anderson, principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation and fraud deterrence programs in the Delaware Valley.  “The company was thrilled that the program performed as well as the Director said it would.  There was not a single person in the company who had any reason to suspect illicit activity.”

The fraud investigation found that the Director of Operations could set the wheels in motion on the fraud from the very beginning.  He negotiated a deal for a significant discount on office supplies with a major office products company that would become the sole supplier of office products for the company’s more than 100 offices in all 50 states, Anderson said.  He then set up a system that allowed each office to submit a requisition for office supplies monthly.

As the requisitions came in each month, the Director consolidated them into a single order with deliveries scheduled for each office.  He then used the monthly invoice from the office products supplier to assign costs to the applicable offices and forward the approved invoice to the corporate accounts payable department for payment, said Anderson, a Certified Fraud Examiner who recommends that every organization enact a comprehensive fraud deterrence program created by an experienced firm that provides forensic accounting services in Philadelphia and the Delaware Valley.

During the fourth year of the program, a newly hired accounts payable clerk was processing the latest invoice when she noticed an oddity.  One of the shipments had been delivered to a small eastern Montana town that was near her own hometown, but it was charged to the Helena office more than 300 miles away.

Anderson said the clerk reported the discrepancy to the Corporate Controller, who contacted the Helena office to inquire about the shipment.  The Helena office manager denied any knowledge about the shipment and denied receipt of the items shipped.  Suspicious, the Controller checked all the shipments on that month’s invoice and found that while some shipments went to company offices, many them went to locations nowhere near company offices.  He took the information to senior management and a forensic accounting expert was engaged to conduct a comprehensive fraud investigation.

What the fraud investigation uncovered — and the Director of Operations admitted — was that once the agreement with the office products supplier had been negotiated, the Director set up his own website to sell office supplies at discounted prices.  As buyers placed orders and paid for them through the website, the Director forwarded the orders to the office products supplier to fill.  When the monthly invoice arrived from the supplier, the Director assigned the cost of each invoiced shipment to the nearest company office.  So, the Helena office — the only office in Montana — was charged for all shipments to Montana, both those ordered by the office and those ordered on the website by unrelated companies or individuals in Montana.

The Director admitted to the forensic accounting expert that his website transactions exceeded more than $100,000 per year, meaning he had shaved $450,000 off the company’s office supplies expenditures over the three years, but stole $300,000 of that for himself.

“He really was very good at his job,” Anderson said.  “He also, unfortunately, was a crook.”

Had the alert accounts payable clerk not noticed the discrepancy with the Montana shipment, Anderson said the theft might have continued much longer.  He added that the entire scheme could have been short circuited simply by having the accounting department assign the invoice costs to each office instead of allowing the Director of Operations to do so.

If your fraud deterrence measures need an overhaul, it’s time to engage a Certified Fraud Examiner from an experienced firm that provides forensic accounting services in Philadelphia and the Delaware Valley.  A Certified Fraud Examiner can examine your accounting and purchasing programs and procedures and make recommendations for enacting strong fraud deterrence measures that will help safeguard your company, Anderson said.

If you require the services of a Certified Fraud Examiner or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson is a forensic accounting expert who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner and a Certified Valuation Analyst.

Watch David Anderson Interview on Collaborative Divorce

The July 23, 2019, interview in which David Anderson, CPA, CFE, CVA, and principal of David Anderson and Associates, explains and discusses the topic of collaborative divorce has been posted to the home page of his corporate website – davidandersonassociates.com.

Anderson, a Philadelphia forensic accountant who provides a full range of forensic accounting services in Philadelphia and the Delaware Valley, was interviewed on the RadioVision TV Network by Bill Borton on the “Live Better Longer” show, a half hour online broadcast that is dedicated to helping baby boomers achieve and live longer and happier retirements.

During his 20-minute discussion with Borton, Anderson, a Certified Valuation Analyst who also is a member of the Collaborative Law Professionals of Southeastern Pennsylvania, talks about the differences between a standard court-administered divorce and a collaborative divorce.

The alternative process of collaborative divorce allows a couple to control the timing and terms of their divorce as opposed to having a judge or third-party mediator determine those outcomes.

A traditional divorce may be more appropriate in such cases where couples, as Anderson said, “have significant enmity between them,” cases which involve emotional or physical abuse, or when the spouses cannot even talk to each other.

A collaborative divorce, Anderson said, “has to be an amicable” because each party and their individual collaboratively trained attorneys work together as a team. This team can be expanded to include collaboratively trained financial specialists (such as a business valuation expert like Anderson), and collaboratively trained coaches (who are either child specialists who help with parenting plans and custody arrangements or mental health professionals who help the parties address emotional issues.

All the team members in a collaborative divorce, said Certified Valuation Analyst Anderson, have undergone specialized training which helps foster cooperation, respect, and open exchange.  Because each spouse is represented by a collaboratively trained attorney, each can feel confident their own views will be adequately considered, and their own needs will be adequately addressed by the team.

The cost for the business valuation expert in a collaborative divorce can be less, because only one expert is retained instead of two, and because the cost of depositions and/or courtroom testimony can be eliminated.

Finally, Anderson explained the difference between collaborative divorce and a mediated divorce – another alternative method of marital dissolution. In mediation, he said, the process is guided by the mediator.  Depending on the type of mediation, either the mediator, the couple themselves or some combination of the mediator and the couple make decisions as to timing, support, custody, and division of assets; in a collaborative divorce, all decisions are made by the couple.  Additionally, while each spouse is represented by a collaboratively trained attorney in a collaborative divorce, there is no requirement in the mediation process that each spouse be represented by an attorney.

If you need a business valuation professional in Philadelphia, or if you require any other services of a forensic accounting expert in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson is a forensic accounting expert in Philadelphia who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Valuation Analyst and a Certified Fraud Examiner in Philadelphia.

David Anderson to be Interviewed on Collaborative Divorce

David Anderson, CPA, CFE, CVA, and principal of David Anderson and Associates, will be interviewed tomorrow on the topic of collaborative divorce on the RadioVision TV Network.

Anderson, a Philadelphia forensic accountant who provides a full range of forensic accounting services in Philadelphia and the Delaware Valley, will appear on Bill Borton’s “Live Better Longer” show, a half hour online broadcast dedicated to helping baby boomers achieve and live longer and happier retirements.

Click here tomorrow – Tuesday, July 23 at 11 a.m. – to see the interview.

In speaking with Borton, Anderson, a Certified Valuation Analyst who also specializes in fraud investigation and fraud deterrence programs, will discuss the alternative process of collaborative divorce that allows a couple to control the timing and terms of their divorce as opposed to having a judge or third-party mediator determine those outcomes.

As explained by Anderson, collaborative divorce gives each party and their attorneys the option to work together as a team.  As necessary, the team can be expanded to include financial specialists (such as a business valuation expert), child specialists (to help with parenting plans and custody arrangements) and coaches (licensed mental health professionals who help the parties address emotional issues).

All the team members in a collaborative divorce, said Certified Valuation Analyst Anderson, have undergone specialized training which helps foster cooperation, respect, and open exchange.  Yet, because each spouse is represented by a collaboratively trained attorney, each can feel confident that their own views will be adequately considered, and their own needs will be adequately addressed by the team.

The cost for the business valuation expert in a collaborative divorce can be less, because only one expert is retained instead of two, and because the cost of depositions and/or courtroom testimony can be eliminated.

If you need a business valuation professional in Philadelphia, or if you require any other services of a forensic accounting expert in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson is a forensic accounting expert in Philadelphia who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Valuation Analyst and a Certified Fraud Examiner in Philadelphia.

Fraud Investigations Can Uncover Inventory Control Weaknesses

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, fraud deterrence, litigation support and expert witness testimony services in Philadelphia and the Delaware Valley.

The anti-fraud controls in place at a shipping supplies company were extensive and outwardly thorough.  Incoming shipments were closely checked against the shipping manifest and outgoing shipments against the sales requisition that then became the invoice.  The warehouse had an alarm to prevent break-ins.  And the company conducted a detailed physical inventory at year-end to determine the quantities and cost of the inventory.  Still, a fraud investigation conducted by a forensic accountant found that more than $20,000 in inventory was being stolen each year and no one at the company had a clue.

“Company management was fully aware of the need for fraud deterrence measures and took what they thought were the necessary steps to protect their inventory,” said David Anderson, principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation and fraud deterrence programs in the Delaware  Valley.  “But without a forensic accountant to guide them, the fraud deterrence steps fell short of what the company needed to safeguard against fraudsters intent on stealing.”

Anderson said the shipping supplies company owner had no idea the fraud was occurring because the controls in place were unable to identify that inventory was missing.  The theft was discovered only by accident.

An outside accountant who prepared the company’s income tax returns also had an outside business selling collectibles on eBay, which was also where he purchased his shipping supplies, Anderson said.  During one purchase, the accountant saw that the seller was local and asked if he could pick up the shipping supplies.  While doing so, Anderson said, the accountant noted that the seller had an uncommon last name, which he realized was the same as that of the general manager at the shipping supplies company that was his client.

The next day, the accountant called his client and learned that the general manager’s son worked in the company’s warehouse, said Anderson, a Certified Fraud Examiner who recommends that every organization enact a comprehensive fraud deterrence program developed by an experienced firm that provides forensic accounting services in Philadelphia and the Delaware Valley.  The accountant informed the company owner that he had purchased shipping supplies from the son and picked them up at the son’s house.

The owner immediately engaged a forensic accounting expert to conduct a thorough fraud investigation.  The forensic accountant’s investigation revealed several holes in the company’s anti-fraud measures, including:

  • The company closely checked incoming and outgoing shipments, but never kept running balances of inventory items, instead relying on the annual physical inventory to provide end of year balances.
  • The alarm system protected against intruders breaking in, but there was no security to prevent employees from simply walking out with inventory.
  • The company never tracked the profitability of individual customer orders and compared them to year-end profitability.
  • Inventory costs were determined only once a year after the physical inventory and were never compared to the costs experienced by similar shipping supply businesses.

Had the company kept a running balance of inventory items, it would have discovered discrepancies with the year-end balances reported after the physical inventory, Anderson said   Further, if the company had tracked profitability of customer orders against year-end profitability and/or compared its inventory costs with those of similar businesses, it would have known its profitability was lower than expected and its inventory costs higher than expected, he said.

“Proper fraud deterrence measures would have raised a red flag,” said Anderson, a forensic accounting expert who also is a Certified Fraud Examiner.  “That would have led the company to investigate the matter and thereby discover the theft much earlier.”

Anderson said the case of the defrauded shipping supply company ends on a cautionary note.  He said the son, when confronted by his father, admitted to the theft.  The company fired the son but declined to file criminal charges to avoid negative publicity.  But the accountant who accidentally discovered the fraud in the first place, notes that the son continues to sell shipping supplies on eBay.  It appears he may have found another job — and another company to defraud.

“Failure to prosecute may solve your immediate problem, but often the fraudster simply moves on to another company,” Anderson said.  “And if that company is inheriting your problem, then it stands to reason you may be inheriting someone else’s problem too.”

If you are confident your fraud deterrence measures are enough to fully protect your company, consider the case of the defrauded shipping supply company owner who thought the same thing.  Perhaps it’s time to engage a Certified Fraud Examiner from an experienced firm that provides forensic accounting services in Philadelphia and the Delaware Valley.  A Certified Fraud Examiner will analyze your company’s entire operation to identify weaknesses that make it vulnerable to fraudulent activities and then recommend strong fraud deterrence measures to help protect the company, Anderson said.

If you require the services of a Certified Fraud Examiner or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson is a forensic accounting expert who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner and a Certified Valuation Analyst.

It Should Always Feel Like Someone is Watching Your Potential Fraudsters

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, fraud deterrence, litigation support and expert witness testimony services in Philadelphia and the Delaware Valley.

Despite what might be a common perception, it’s much more effective to let your employees know – right up front – that’s you’re constantly looking over their shoulders for fraudulent activities and that numerous deterrence measures are in place.

“Today, people are used to being watched,” said David Anderson, principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation and fraud deterrence programs in the Delaware Valley.  “Cameras are everywhere — at red lights, private residences, inside stores, and outside in parking lots too. And everyone’s got a camera on their cell phone. It’s no wonder criminal activity is down in areas where people are — or think they are — under surveillance.  The same is true regarding fraud.”

Anderson doesn’t advocate actual video surveillance of employees, but rather that organizations convey clearly to employees that they constantly are watching for fraudulent activities. By implementing several relatively inexpensive steps, Anderson said organizations can let employees know that fraud deterrence is a critical organizational goal.

The first step is to develop and publish a code of conduct and an anti-fraud policy that lets employees know:

  • Fraud is unacceptable and will not be tolerated;
  • Every employee is responsible for being alert to the possibility of fraud;
  • It is the duty of every employee to not turn a blind eye to fraud; and
  • Management will be actively instituting such anti-fraud measures as surprise audits, regular management review, mandatory job rotation, mandatory vacations, fraud training for employees and managers, and (possibly) the institution of a fraud hotline.

The key to effective deterrence, however, is to follow through on these anti-fraud measures.

“Your fraud deterrence program isn’t going to work if you make a point about being on the lookout for fraud, then do nothing to indicate you’re actually watching,” Anderson said.  “Besides, you don’t want to wait until you get to the point where you have to hire a Certified Fraud Examiner to conduct a fraud investigation.  You want to prevent fraud from happening.  If employees think you are watching, they might not be inclined to steal in the first place.”

Carrying out anti-fraud measures does not need to be expensive.  Anderson suggests a few well-timed surprise audits – of petty cash, bank accounts and inventory – sprinkled throughout the year.

“I particularly like a surprise count of petty cash at 4:00 p.m. on a Friday or the day before a holiday because there is a greater chance of petty cash being taken for use in those instances,” said Anderson, a Certified Fraud Examiner who encourages companies, non-profits and government offices to enact a comprehensive fraud deterrence program created by an experienced firm that provides forensic accounting services in Philadelphia and the Delaware Valley.

Anderson notes that inventory need not be counted in total, but certain items that are high value, have a high turnover, or are prone to fraud could be subject to a surprise count once a month.  Annual fraud training for employees and managers also is not financially burdensome – nor is a fraud hotline, he said.

“These measures let your employees know that your organization is serious about fraud deterrence and that employees are, in effect, under surveillance for illicit activities,” Anderson said.  “Enacting these measures and then carrying them out will greatly reduce the potential for fraud.”

If you require the services of a Certified Fraud Examiner or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner and a Certified Valuation Analyst.

An Overview of Business Valuation – Part Five

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of business valuation and other forensic accounting services in Philadelphia and the Delaware Valley. This is the final installment of a five-part series in which Anderson reviews the basics of business valuation.

The process of determining the worth of a business is a complicated one.  A business valuation expert must undertake a series of preliminary steps to set the groundwork and then consider the value of the business from three very distinct approaches before forming a professional opinion as to the initial value.  With this process completed, there remains just one final step: considering potential adjustments to the initial value.

“The process is complex,” said David Anderson, principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of business valuation and other forensic accounting services in Philadelphia and the Delaware Valley.  “There are myriad factors that must be considered and weighed by the valuator to reach the point of establishing initial value.  But that initial value still is not accurate until possible adjustments to the value are considered.”

Anderson said business valuation experts must consider four types of potential adjustments:

  • Non-operating asset adjustments
  • Control adjustments
  • Marketability adjustments
  • Other adjustments

Non-operating asset adjustments involve assets and associated liabilities that are not part of the normal operations of a business, according to Anderson, a business valuation expert in Philadelphia and the Delaware Valley.  As an example, Anderson explained, a food processing company may own a collection of artwork that is not related to its business operations.  Or, a computer consulting firm may own an office building (with a mortgage) that it does not use but leases out to other companies.

Valuators may remove these assets and liabilities from consideration during the business valuation process in order to more accurately assess the worth of the actual business operations, Anderson said.  But once the initial value of the business has been established, these assets and liabilities must be considered because they are owned by the business and therefore affect its overall value.

Control adjustments may be warranted if a business valuation expert is considering the value of some, but not all, of the shares of a business, Anderson said.  If the shares being valued would give a buyer control of the business, they carry a higher value than other shares.

For example, Anderson said, a buyer would have control of the company if either the shares are more than 50 percent of the total or they give the buyer more than 50 percent of the total voting rights (assuming a simple majority is all that is required).  However, if the shares represent a “minority interest” in the company, the buyer would not have control or significant influence in company operations.  Under that circumstance, Anderson said, the buyer is likely to demand a price adjustment known as a discount for lack of control.  The specific discount (usually a percentage of the price per share) is typically based on data from sales of shares in publicly held corporations.

Marketability adjustments come into play when privately held businesses are being valued, Anderson said.  Typically, there are no readily available public markets for privately held businesses.  As a result, it is more difficult to sell shares in a privately held business because it likely will take longer and cost more to find a buyer.

A buyer of shares in a privately held business, therefore, is likely to demand a price discount known as a discount for lack of marketability.  The specific discount (usually expressed as a percentage of the value of the business or of the price per share) is typically based on the valuation method(s) selected by the business valuation expert, information regarding marketability discounts of comparable companies, and the particular facts and circumstances of the business being valued.

Other adjustments the business valuation expert must consider to determine if they are applicable include:

  • Built-in gains discount
  • Blockage discount
  • Key person discount (also known as personal goodwill discount)
  • Restrictive agreement discount
  • Investment company discount
  • Lack of voting rights discount

Once all potential adjustments have been applied as necessary, the business valuation expert can finally arrive at a final value for the business.

“As you can see, the process of valuing a business is quite involved,” Anderson said.  “When a business valuation is made for tax, divorce or litigation purposes, the best way to properly protect the rights of the persons for whom the valuation is being performed is to have the valuation conducted by a qualified, experienced business valuation expert who follows professional business valuation standards.”

If you require the services of a business valuation expert in Philadelphia or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner, a Certified Valuation Analyst and a business valuation expert in Philadelphia.

An Overview of Business Valuation – Part Four

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of business valuation and other forensic accounting services in Philadelphia and the Delaware Valley. This is the fourth of a five-part series in which Anderson reviews the basics of business valuation.

Business valuation experts must undertake a series of preliminary steps to set the groundwork for determining the worth of a business.  Once those steps are complete, valuators must consider three very distinct approaches to valuing a business.

In earlier postings, David Anderson, principal of David Anderson & Associates, explained the first three steps of the business valuation process — determining the standard of value, deciding on the premise of value and normalizing financial statements.

In this fourth installment of the series, Anderson reviews the three most commonly used approaches to valuing a business: The Income Approach, the Asset-based Approach and the Market Approach.

“Professional business valuators are required to consider all three approaches,” said Anderson, a business valuation expert in Philadelphia and the Delaware Valley.  “In the end, a business valuation expert must use his or her judgment to determine the best approach or combination of approaches to arrive at a business valuation that is as fair and accurate as possible.”

The most common approaches a business valuation expert will consider are the three noted below:

  • Income Approach values a business by using one or more methods to convert anticipated economic benefits (earnings or cash flow) into a single present amount. There are two primary methods under this approach:
    • Capitalization of Earnings/Cash Flows Method, which is used when there has been a steady level of historical growth, and the
    • Discounted Earnings/Cash Flow Method, which is used when there have been fluctuations in historical growth and when the company can reasonably project earnings for the next five or more years.
  • Asset-based Approach values a business by calculating the value of net assets, which is the difference between total assets and total liabilities. There also are two primary methods under this approach:
    • The Book Value Method, which calculates the net asset value as shown on the books of the business – typically at historical cost, and the
    • Adjusted Net Asset Method, which adjusts the value of assets and liabilities to the fair market value as of the valuation date.
  • Market Approach values a business by comparing it to sales of similar businesses. There are four primary methods under the Market Approach:
    • Analyze transactions of comparable publicly held companies;
    • Analyze transactions of comparable privately held companies;
    • Analyze prior transactions involving shares of the company itself, and lastly,
    • Analyze the ability of the company to pay shareholder dividends and compare that to dividends paid by comparable companies.

“The specific methods used depends on the facts and circumstances surrounding the business being valued,” said Anderson, whose company – David Anderson & Associates – is a Philadelphia forensic accounting firm that provides a full range of business valuation and other forensic accounting services in Philadelphia and the Delaware Valley. “For example, if there are no comparable market transactions or an insufficient number to be meaningful, the Market Approach may not be useful.”

Once the value of the business has been set under each of the approaches, the business valuation expert must determine whether one of the values is the best representation of the true value of the business or if a weighted blend of the values provides a more accurate final business value, he said.

Anderson gives the example of valuing a startup business with little profitability.  The Income Approach might yield a very low value because the startup hasn’t had time to show historical growth, while the Market Approach might result in a considerably higher value based on the sale of comparable businesses.

“Under this scenario, some valuators would select the Market Approach as being most indicative of value and others might choose a blend of the Income Approach and Market Approach with a higher weight on the Market Approach,” he explained.  “It all comes down to the professional judgment of the business valuator, based on his or her experience and knowledge about the business being valued.”

At this point, the complex process of business valuation is nearing the end.  But there is still one major step remaining before a final determination on the worth of a business can be made: Consideration of certain adjustments for non-operating assets as well as control, marketability and other adjustments.  Anderson will explore these adjustments in the next and final installment of “An Overview of Business Valuation.”

If you require the services of a business valuation expert in Philadelphia or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner, a Certified Valuation Analyst and a business valuation expert in Philadelphia.

An Overview of Business Valuation – Part Three

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of business valuation and other forensic accounting services in Philadelphia and the Delaware Valley. This is the third of a five-part series in which Anderson reviews the basics of business valuation.

Determining the worth of your business can be quite complicated. Before the actual business valuation can begin, several steps must be taken.

“The value of a business often depends on the earnings it generates,” said David Anderson, a business valuation expert in Philadelphia and the Delaware Valley and principal of David Anderson & Associates.

“Small business owners” he said, “have a fair amount of latitude in choosing how they report the financial operations of their business, often selecting alternative accounting practices that lessen their income tax obligation.”

In two earlier posts, Anderson explained the first two steps of the business valuation process — determining the standard of value and deciding on the premise of value.  This third in a series of articles examines the steps a business valuation expert sometimes must take to bring a company’s financial statement on an equal footing.

Because of these alternative practices, he explained, a business valuation expert frequently needs to adjust the historical financial statements before implementing selected business valuation approaches and methods.  Making these adjustments is often referred to as “normalizing” the financial statements.

“Normalizing the financial statements should provide the valuator with a more economically realistic picture of the value of the assets and the financial operating results of the business,” Anderson explained.

These financial statement adjustments represent estimates and often fall into one of the three categories as noted below:

Comparability adjustments are intended to make the company more comparable to guideline companies or companies within the industry group that were used in comparative ratio analyses.  For example, if the company being evaluated used the last in, first out (“LIFO”) inventory method of accounting while the industry group uses the first in, first out (“FIFO”) inventory method, this adjustment would give a valuator a clearer picture of how the company’s financial statement compares to others in its industry.

Non-operating or non-recurring adjustments are removed from the income statement because they are either unrelated to the business operations or unlikely to recur in the future.  Non-operating assets or liabilities are elements of the balance sheet that are removed so a more appropriate value of the operating company may be determined.

These assets or liabilities are then added or subtracted to the resulting computed value to arrive at the total equity value of the company.  An example of these types of adjustments would be the costs associated with discontinuing a portion of the business.

Discretionary adjustments are those expenses that are usually under the sole discretion of management, or more typically, the owners of the business.  Often these expenses are between the company and the owners of the company (i.e., related party transactions).  These adjustments are most appropriately made when valuing a controlling interest in the company and they generally represent the difference between the actual recorded book expense and the expense that would be incurred if transacted between the company and an independent third party.

Examples of these types of adjustments include: Officer’s and owner’s compensation, owner’s perquisites, entertainment expenses, automobile expenses (e.g., personal use of company cars), compensation to family members, and other related party transactions.

Once these three types of “normalization” adjustments have been made to the financial statements, the business valuation expert can begin to analyze the value of the business under each of the different valuation approaches and methods, Anderson said.

In upcoming weeks, Anderson will continue to explore the process business valuation experts undergo to determine the worth of a business.

If you require the services of a business valuation expert in Philadelphia or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner, a Certified Valuation Analyst and a business valuation expert in Philadelphia.

An Overview of Business Valuation – Part Two

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of business valuation and other forensic accounting services in Philadelphia and the Delaware Valley. This is the second of a five-part series in which Anderson reviews the basics of business valuation. 

Knowing how to calculate a value of your business that is fair and accurate is a skill with which every corporate principal should be familiar.

“You don’t want to rely on estimates, gut instinct, or rumored calculation methods to determine business value,” said David Anderson, principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of business valuation and other forensic accounting services in Philadelphia and the Delaware Valley.  “When you need to know the true worth of your business, you need to understand the process.  And you need the expertise of a highly qualified business valuation expert.”

In last week’s opening segment of this five-part blog series, Anderson covered the first step of business valuation: Determining the standard of value.

“The second step in ascertaining a company’s worth,” he said, “is to decide on the premise of value.”

The premise of value is the type of transactional circumstances underlying the business or property being valued, Anderson said, adding that there are four premises of value:

  • Going Concern Value
  • Book Value
  • Liquidation Value
  • Replacement Value.

Going Concern Value is the most frequently used premise of value. This method assumes the business is operating and producing revenues . . . and will continue to do so.

Book Value is the difference between a company’s total assets that have been adjusted for depreciation, depletion, and amortization and the amount of total liabilities as listed on the balance sheet.  Assets such as real estate, collectibles, and artwork are recorded at historical cost and therefore may be undervalued on the balance sheet.  Intangible assets such as patents, copyrights and trademarks also may be undervalued.

Interestingly, many buy-sell and shareholder agreements use Book Value to establish share value when a shareholder wishes to sell shares back to the company or when shares are purchased after a shareholder is terminated or dies.  In these cases, disputes often arise when the Book Value of the shares is significantly less than the Going Concern value.

Liquidation Value is the net amount realized if the business is terminated and the assets are sold individually.  Liquidation Value typically results in the lowest of the premises of value, Anderson said.

Replacement Value generally is used for specific assets and refers to the current cost of property equivalent to the property being valued.  Replacement Value is often used in insurance contracts for calculations involving real estate or tangible personal property and in construction or manufacturing agreements.

“Determining these two crucial steps — the standard of value and the premise of value — will allow a business valuation expert to select the appropriate valuation methodology to decide your company’s worth,” Anderson said.

Over the next several weeks, Anderson will post additional articles on the specific methods business valuation experts use to establish value, the effect non-operating assets have on business valuation and discounts for lack of control and lack of marketability. Coming up next in Part Three, an examination of the steps a business valuation expert sometimes must take to bring a company’s financial statement on an equal footing.

If you require the services of a business valuation expert in Philadelphia or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner, a Certified Valuation Analyst and a business valuation expert in Philadelphia.

An Overview of Business Valuation – Part I

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of business valuation and other forensic accounting services in Philadelphia and the Delaware Valley. This is the first of a five-part series in which Anderson reviews the basics of business valuation.

Do you know what your business is worth? If not, you probably should.

There are many reasons why it’s important to know. These can range from business reasons, such as calculations related to any acquisitions or mergers, to personal issues of estate planning and resolution to marriage dissolution.  When the time comes, understanding how a fair and accurate business valuation is determined is of paramount importance.

“The first step in valuing a business is to determine the standard of value,” said David Anderson, principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of business valuation and other forensic accounting services in Philadelphia and the Delaware Valley.  “This is the type of value that is being requested for the business.  The three most common standards of value are fair market value, fair value and strategic/investment value.”

The IRS defines fair market value as “The price at which the property would change hands between a willing buyer and a willing seller, when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”

Fair market value is the most widely recognized and accepted standard of value, according to Anderson, a business valuation expert in Philadelphia and the Delaware Valley.  Fair market value is used to establish value for all Federal tax matters, including estate tax, gift tax and income tax, he said.  This standard also is used for many purchase, sale and merger transactions; for buy-sell agreements; for regulatory valuations; and for most litigation matters, including partner/shareholder disputes, divorces and economic damage cases.  Fair market value takes into consideration discounts for lack of control and lack of marketability.

Fair value generally is defined as fair market value without considering discounts, Anderson said.  Fair value principally is used to value the shares held by a company owner with a minority interest when that person believes he is being forced to receive less than adequate compensation for his shares.  Fair value is the standard of value used in divorce cases in New Jersey.  Additionally, fair value with a discount for lack of marketability is used in divorce cases in New York.

Strategic/investment value is the value to a particular investor based on individual requirements and expectations, according to Anderson.  This standard most often is used for a purchase, sale or merger in which the buyer expects to realize certain synergies with the seller’s business.  Strategic/investment value typically is higher than fair market value because of these synergies.

“The standard of value is one of the key components used to determine the valuation methodology to be employed and, ultimately, the business valuation expert’s decision on the value of your business,” Anderson said.

Over the next four weeks, Anderson will post additional articles on the specific methods business valuation experts use to determine value, the effect non-operating assets have on business valuation and discounts for lack of control and lack of marketability.  Up next in “An Overview of Business Valuation – Part II:” Determining the premise of value, the type of transactional circumstances that underlies the business or property being valued.

If you require the services of a business valuation expert in Philadelphia or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner, a Certified Valuation Analyst and a business valuation expert in Philadelphia.

Why You Shouldn’t Give a Fraudster a Second Chance

David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of fraud investigation, forensic accounting, and marital dissolution services in Philadelphia and the Delaware Valley.

We are taught to forgive others who make a mistake, and to usually offer them a second chance.  While this philosophy may apply to many of our life experiences, I strongly recommend against it in the case of someone who has committed fraud.

The 2018 Report to the Nations from the Association of Certified Fraud Examiners (ACFE) found approximately 40 percent of all fraudsters, when caught, are not terminated by their employers.  This 40 percent are:

  • 12 percent reached a settlement agreement, usually confidential, and left the organization
  • 10 percent were permitted to or required to resign without being terminated
  • 8 percent were placed on probation or suspension
  • 6 percent received no punishment at all
  • 4 percent made restitution and stayed with the organization.

The above numbers are higher if the employee is an executive (53 percent):

  • 18 percent reached a settlement agreement, usually confidential, and leave the organization
  • 16 percent were permitted to or required to resign without being terminated
  • 7 percent were placed on probation or suspension
  • 12 percent received no punishment at all

The fact that such high numbers of fraudsters may leave without being terminated or remain with their organizations can have significant implications.  For example, the 22 percent of fraudsters who are permitted to leave without being terminated may be allowed to file for and collect unemployment payments.  This, in turn, raises the cost of unemployment insurance for the organization.

Also, because organizations fear being sued if they provide negative information to a new employer, the new employer of the fraudster may be unaware the employee previously committed fraud.  In fact, the 2018 Report to the Nations noted 6 percent of employees who committed fraud had been previously charged but not convicted and an additional 4 percent had a prior conviction for fraud (these numbers rise to 9 percent and 6 percent, respectively, for executives).  In most of these cases, the second employer found out about the previous fraud only after becoming a victim themselves.

Additionally, insurance companies may decline to pay claims of organizations who allowed a fraudster to remain with the organization and/or commit subsequent frauds.

Let’s also consider what happens when an employee who committed fraud remains with the organization.  In previous blogs, I discussed the Fraud Triangle – the three aspects (Pressure, Rationalization and Opportunity) necessary to enable a fraud.  What really changes when the employee remains?

  • What Pressure did the employee face? Was it an addiction (to drugs, alcohol, gambling, shopping, etc.)?  Was it financial (debts, medical expenses, need to maintain an outward lifestyle)?  Despite verbal promises from the fraudster to not commit a future fraud, if the Pressure is not removed, it will continue to impact the employee.
  • What Rationalization did the employee make to justify committing the fraud? Was it that the employee felt underpaid and/or unappreciated?  Did the employee feel that since management ignored the rules, it was okay for the employee to do so?  Did the employee feel the organization could “afford” to lose money through the fraud?  What changes will the organization make to remove the basis for the Rationalization?  If these changes are not made, the Rationalization will continue to impact the employee.
  • What Opportunity allowed the employee to commit the fraud? Will the organization make the necessary changes in controls and oversight, and continue to rigorously enforce them in the future?  Or, will management begin to relax those controls if they start to feel comfortable with the employee?

Two cautionary examples which I have encountered show this problem:

In the first case, an auto dealership sales manager “created” a dealership rebate to help a customer purchase a car.  Instead of discounting the price of the car by $1,000, the sales manager had the dealership write a check to the customer for $1,000.  The customer used the check as down payment on the car in order to obtain a car loan (the bank required that the customer provide a $1,000 down payment in order to show “equity” in the car).

When this fraudulent scheme worked, the sales manager began to regularly offer similar dealership rebates to help customers obtain car loans (in one case, a rebate as high as $5,000).  This helped the sales manager meet his quotas and earn bonuses and higher sales commissions.  Unfortunately, many of these customers who used the dealership rebate as down payment defaulted on their loans.

The higher-than-normal default rate lead to investigations by the lenders who invoked “claw back” clauses in their agreements with the car dealership, and the dealership lost many thousands of dollars due to the claw backs.  Rather than terminating the sales manager, the auto dealer allowed the manager to remain with the promise that he would never again use the dealership rebate scheme.  The sales manager made good on his promise for almost a year.

However, one month, the sales manager was one car short of making his bonus quota for the month.  A customer was $500 short of the required down payment on a car.  The sales manager decided to give the customer a $500 dealership rebate.  He earned his bonus for that month but promised himself this was a one-time only indiscretion.  Because the auto dealer had relaxed his controls and oversight of the sales manager, he never noticed the rebate.

Of course, two months further along, the sales manager decided to offer another customer a dealership rebate, and before long, he was back to regularly using the dealership rebate.  The cycle of customer loan defaults, investigations and claw backs followed.  But this time, the dealership also lost several of its lender relationships, and the total weight of cost to the dealership lead the auto dealer to terminate the sales manager.

In another case, the Controller of a retailer embezzled funds by submitting false (and in most instances, duplicates of the same invoices) employee reimbursement requests.  When caught, the Controller apologized, agreed to make restitution through regular payroll deductions, and stated that she would never commit fraud again.  The business’s owner, who regularly had the business pay personal expenses he directed the Controller to charge as business operating expenses, agreed to let the Controller remain.

After about six months, he relaxed his increased oversight of the Controller.  The Controller then began a series of fraudulent schemes which included ceasing repayment of her restitution; additional submissions of false employee reimbursement requests; and accepting kickbacks from customers in return for processing phony credits against their purchases.  When these schemes were discovered, the Controller was terminated.

The additional frauds ended up costing the company several times the amount taken in the original fraud.  Our investigation also revealed a subordinate of the Controller was aware of the subsequent frauds but was afraid to report them because the Controller hadn’t been terminated after being caught in the initial fraud.

If you require the services of a Certified Fraud Examiner in Philadelphia or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, fraud deterrence, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson is a forensic accounting expert in Philadelphia who has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Valuation Analyst and a Certified Fraud Examiner in Philadelphia.