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Even With No Profits, Can a Business Have Value?

Posted by & filed under Blog Articles, Company News, Forensic Accounting, Fraud, Fraud Deterrence.

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.

 Unearthing value in an unprofitable business might seem to make as much sense as wringing water out of a rock, but – by putting forensic accounting principles to work – a knowledgeable business valuation expert can do just that.

“Business valuators look to three primary methods for valuing a business: The Income Method, the Market Method, and the Asset Method. Most of these valuators primarily rely on the Income Method because a ‘hypothetical’ buyer is looking for value from the profits and cash flows of a business,” said David Anderson, a Certified Valuation Analyst and 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. “It then makes sense that if a business isn’t making a profit, it would not be of any value to a potential buyer. That, however, is not necessarily true.”

How can this be? There are several scenarios under which an unprofitable business can have value.

  • The first is a startup business. Typically, the costs of starting up a business and ramping up its sales can be incurred over several years. During that time, the business usually operates at a loss.  However, because of the future earnings potential, investors are willing to give a business value based on this potential.
    • Case in point: Just Eat Takeaway, a European-based online food ordering and delivery company that purchased Grubhub in 2021, lost $5.7 million in 2022 on revenues of $5.6 million, and also had losses in each of the last four years. This hasn’t stopped investors from putting hundreds of millions of dollars into the company. Today, it is publicly traded with a market cap of approximately $3 billion.
  • Similar to startup businesses are those that are in bankruptcy. Such companies typically have been unable to produce sufficient profits to cover operating costs and debt service (the cost of repaying debt with interest). Through the bankruptcy process, these companies are able to shed their debt which makes them attractive to potential investors who focus on the potential future profitability of the debt-free company.
    • Case in point: Core Scientific, which engages in digital currency mining, had lost money in three of the last four years, and filed for bankruptcy in December 2022. Today, although it has not yet emerged from bankruptcy, it is still publicly traded with a market cap of over $130 million.
  • A third type of unprofitable business that can have value is one that has assets with a value that exceeds the liabilities and debts of the business. In this case, notes David Anderson & Associates, a business valuation expert in Philadelphia that also serves as a Philadelphia forensic accounting firm, a potential purchaser is less concerned with the profitability of the business it is acquiring, and is very interested in the assets of the business, and the value they will add to the purchaser’s business.
    • Case in point: AES, Inc., a large utility headquartered just outside of Washington, D.C., has had operating losses in each of the last two years. Its assets exceed its liabilities by approximately $4.5 billion, yet AES, Inc. has a market cap of over $14 billion.

Unprofitable businesses can have value to the “hypothetical” and real buyer, concludes David Anderson, a business valuation expert in Philadelphia. In each of these scenarios, the purchaser sees the potential for value in the future operations of the business.

If you require the services of a Certified Valuation Analyst, or 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 Aren’t You as Good as the Fraud Investigators on TV?

Posted by & filed under Blog Articles, Company News, Forensic Accounting, Fraud, Fraud Deterrence.

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.

On TV, especially in police procedurals, fraud investigators are able to access banking records, credit card information and tax returns within minutes of identifying the perpetrator. In addition, they are able to easily identify fraudulent activity by briefly viewing these records.

Unfortunately, this is seldom the case in the real world. Nevertheless, some of my fraud investigation clients seem surprised that I can’t easily and quickly obtain banking records, credit card information, tax returns, and other personal financial information. Others don’t understand why I can’t just look at a transaction and immediately determine if it is fraudulent or not. This blog discusses why this is the case. My focus will be on civil litigation and criminal defense.

In civil litigation, the forensic accountant must depend on the counsel with whom he or she is working to subpoena business and personal records. The other side can dispute the need to provide these records and can insist that the Court decide which records must be provided (and under what circumstances). Additionally, the other side can delay up to the Court’s time limit and can provide records in a haphazard, incomplete, or burdensome way which can require significant time and resources to analyze them. Banks and credit card companies can also insist on payments for copies of statements, cancelled checks and deposit slips. Companies can demand payments for copying costs. All-in-all, it can be quite burdensome to obtain these records.

Once the forensic accountant has obtained and analyzed the records, the forensic accountant must depend on the client to identify which transactions are improper and unauthorized (we are not permitted to say fraudulent – that is a legal finding which is up to the Court or a jury). It is not necessarily the case that every check written to the employee or employee’s family members and/or every personal charge on company credit cards by the employee is improper and unauthorized.

For example, in a recent case, I found a check for a significant amount which the perpetrator had written to herself, and which appeared to have been improperly recorded as a distribution to the owner. However, upon reviewing the check with the client, I learned that the client had authorized the payment as a short-term personal loan from the owner to the employee. The employee had directly repaid the owner.

In another case, I found payments made by the company directly to the perpetrator’s divorce attorney (the employee was a non-owner). Upon reviewing this with the owner, I learned that the owner had approved these payments due to the employee’s long and loyal service to the company (which, of course, turned out to be not so loyal). In this case, the owner was also at risk for recording legal costs which were not valid costs of the business.

In a third case (involving improper and unauthorized credit card charges), the owner had allowed the perpetrator to pay for one personal family dinner per month using the company’s credit card, and to have the expense recorded as a company business expense (again, an additional business risk for the owner).

Having to review specific transactions can sometimes be overwhelming for a client, but the forensic accountant needs this additional level of verification to prevent the risk that the forensic accountant has identified one or more valid transactions as improper and unauthorized.

For criminal defense litigation, I interviewed Philadelphia federal criminal defense and white-collar crime attorney NiaLena Caravasos (https://nialena.com/). Ms. Caravasos advised me that for criminal litigation, the government is generally required to share with the defense all of the relevant documentation and other information it has received.

However, there may be additional information which the defense needs but which the government has not obtained. For example, the defense may desire to see the defendant’s Outlook work calendar, even though the government did not obtain this information. As a result, the criminal defense attorney will seek to obtain it from the defendant’s employer. In this case, the process is similar to that of civil litigation. The criminal defense attorney requests the Court to issue a subpoena for the desired information. This then affords the third party the opportunity to dispute the subpoena with potentially the same results as described above for civil litigation.

Again, once the forensic accountant has obtained and analyzed the records, the forensic accountant must depend on the client to review each transaction and indicate a potential defense for some or all of the transactions. In such cases, the forensic accountant might need to perform additional work in order to support the client’s defense (for example, locating an e-mail authorizing the client to make a personal charge on the company’s credit card, or additional analysis of the company’s credit card transactions to show that it was a regular practice of the owner to allow employees to make personal charges on the company’s credit card account).

So, the next time you see a forensic accountant on television easily identify fraud and catch the perpetrator by the end of the hour, remember that this is so only through the magic of television. In the real world, forensic investigations take a lot of time and effort on both the part of the forensic accountant and the client.

If you would like to speak with such 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 with more than 30 years of experience in financial and operational leadership positions. He is a Certified Public Accountant, a Certified Fraud Examiner, and a Certified Valuation Analyst.

How Tone at the Top Impacts Your Company’s Fraud Risk

Posted by & filed under Blog Articles, Company News, Forensic Accounting, Fraud, Fraud Deterrence.

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.

In my previous discussions about the Fraud Triangle – the three factors that must be present for fraud to occur – one of those factors was Rationalization: The mental process a potential fraudster goes through to justify committing the fraud. Without being able to rationalize to oneself why it is OK to commit the fraud, a potential fraudster with Opportunity and Pressure – the other two key factors in the Fraud Triangle – is unlikely to proceed.

Tone at the Top – management’s attitude towards honesty and ethical behavior – can have a significant impact upon an employee’s likelihood to commit fraud. Employees typically take their cues from management. If management has clearly stated that fraud is unacceptable in the company’s written policies, in employee training, and in how management acts, then employees will be less likely to commit fraud.

However, regardless of what management says, if management shows a disdain for fighting fraud or plays “fast and loose” with rules and regulations, employees are more likely to rationalize it is OK for them to commit fraud.

Here are a few examples:

  • In a large real estate development company, the owner had his CFO rent, at the company’s expense, a luxury apartment for the owner’s girlfriend to use, and had the company acquire an expensive car for the girlfriend to drive. The girlfriend was neither an employee nor contractor of the company. When the CFO saw an opportunity to exploit a weakness in the company’s payroll software, he used the weakness to embezzle over $3 million from the company. When caught and questioned, he stated that since the owner of the company was cheating the government, he figured it would be okay to cheat the company.
  • Similarly, the owner of furniture store chain regularly bragged to his controller that he was having the company pay for an expensive home theater room and expensive bathroom hardware for his vacation home. He directed the controller to hide the expenses so that “the IRS won’t find out.” The controller began to have personal financial problems and started taking money from the company through various fraudulent schemes. When confronted by the owner, she threatened to turn him in to the IRS if he reported her. The owner allowed her to keep working for another year, and to keep taking funds through other schemes, and finally contacted his lawyer about how to manage this. If he had contacted us (or a good lawyer), we would have advised him he could have filed amended tax returns with the IRS and paid the additional taxes plus some interest and penalties, instead of allowing the controller to continue to commit fraud.
  • The owners of a consulting business regularly charged personal expenses, including vacations and personal purchases to their company credit card. They told the controller to record the personal expenses as business expenses. The controller ordered an additional company credit card in her name, charged her own personal purchases to the company credit card, and recorded the charges as the company’s business expenses. When we investigated and confronted her, she, too, stated that since the owners were “cheating” she figured it would be okay for her to cheat the company.
  • A construction company owner had his bookkeeper “adjust” employees’ work records to show fewer hours than they actually worked. He also regularly instructed his bookkeeper to not pay certain vendors until the vendors threatened to sue the company. He would then negotiate reductions in the vendors’ bills. The bookkeeper’s husband became ill and was laid off from his job. Because of the financial pressure, the bookkeeper began writing checks to herself to help her cover her expenses. She recorded the checks as having been paid to various vendors. When we investigated and confronted her, she told us that because she needed the money, and saw how the owner regularly defrauded others, she felt it was okay to defraud him since she was only taking monies to which he was not entitled.

The above examples illustrate how the Tone at the Top of each of these companies contributed to the fraudsters rationalization that it was okay for them to improperly take funds from the company. In essence, each fostered a culture of improper behavior, and each suffered because employees reflected the behavior of management.

If you would like to speak with such 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 with more than 30 years of experience in financial and operational leadership positions. He is a Certified Public Accountant, a Certified Fraud Examiner, and a Certified Valuation Analyst.

An In-Depth Look at Accounts Receivable Fraud

Posted by & filed under Blog Articles, Company News, Forensic Accounting, Fraud, Fraud Deterrence.

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.

Among the less-frequent but more-expensive frauds are those targeting Accounts Receivable.  In this column, I’ll discuss some of the Accounts Receivable-related frauds I have encountered.

Fraudsters can manipulate Accounts Receivable to conceal their diversion of payments made by customers.  A common element of these diversions is that the fraudster has set up separate bank accounts under his/her control, and that the bank account names are similar to that of the business being defrauded.

For example, if the business being defrauded is ABC Services Company, the fraudster may set up a business entitled “ABC Company”.  The fraudster can then deposit checks made payable to ABC Services Company by its customers.  Additionally, the fraudster can provide new wire instructions to ABC Services Company customers with the ABC Company name.

Because the names are so similar, most customers won’t notice the small difference in company name.  Additionally, banks allow leeway in processing checks made out to a similar name and may not notice the difference either. (For example, some customers may just make their checks out to “ABC.”)

If the perpetration of the fraud is based on diverting customer checks, the fraudster either needs to provide customers with a new mailing address (such as a P. O. Box under the fraudster’s control) or have the ability to open mail and remove the customer’s checks before entry into the company’s accounting system.  If the perpetration of the fraud is based on diverting customer wires, the fraudster needs the ability to “hide” receipt of the wires into the alternate bank account.

So, how can the fraudster manipulate the fact that payments have not been received by the company?  Here are a few of the ways:

  • If the fraudster has control of credit, collections, and bad-debt write-offs, the fraudster can just allow the unpaid customer invoices to sit on the system and get older and older. Eventually, the fraudster writes off the unpaid invoices to bad debts.
  • Depending on the type of accounting system in place, the fraudster can cancel the customer invoice. Of course, if the accounting system is tracking inventory, the cancellation would cause the system to show a higher amount of inventory than exists.  However, if the accounting system does not track inventory or if the company is providing services instead of products, this won’t be a problem for the fraudster.
  • If the fraudster has the ability to post credits against a customer’s account, the fraudster can post a credit (for such things as sales discounts, sales adjustments, sales returns and allowances, etc.) against the invoice paid by the diverted check or wire to eliminate the invoice balance.

Because the above schemes are more complex than other fraud schemes (such as theft of cash or inventory), it is usually a higher-level accounting person (such as a Chief Financial Officer, Controller or Accounting Manager) who perpetrates this type of fraud.

So, how can a company defend itself against Accounts Receivable fraud.  Here are a few recommendations:

  • Management should require and review a regular monthly report of open invoices by age. Once an invoice reaches a certain age (for example 45 days past the billing date), a more senior employee outside the accounting department should be asking the customer why the invoice is unpaid and when it will be paid.
  • Management signoff should be required (and documented) for any credits posted to customer accounts, whether for sales discounts, sales adjustments, sales returns and allowances, etc.
  • Management should implement an invoice numbering system that allows for tracking of invoice numbers. It should require and review a regular monthly report of invoice numbers to include customer name and billing date.  An explanation should be required for any gaps in invoice numbers.
  • Management (or a more senior employee outside of the accounting department) should periodically verify with each customer’s accounts payable department the check mailing addresses and wire instructions to make sure they have not been changed.

In cases where management lacks the time to perform the above tasks, or the company is too small to separate duties sufficiently, corporate leaders should consider engaging a reliable and impartial outside forensic accounting expert to perform these services.

If you would like to speak with such 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 with more than 30 years of experience in financial and operational leadership positions. He is a Certified Public Accountant, a Certified Fraud Examiner, and a Certified Valuation Analyst.

Forensic Accountants Can Play Key Role in Resolving Family Inheritance Disputes

Posted by & filed under Blog Articles, Company News, Forensic Accounting, Fraud, Fraud Deterrence.

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.

Family arguments over such minor issues as toys, chores, or family rules are quite common among siblings, cousins, and other relations.

However, these youngsters often grow up and get engaged in more meaningful, and significant, disagreements over trusts, estates, and other inheritance issues.

This is where the services of a forensic accountant can come into play.

“Unfortunately, there rarely is a family member who can step in as the ultimate arbiter to settle the conflict,” said David Anderson, principal of David Anderson & Associates, a Philadelphia forensic accounting firm.  “Instead, the unhappy beneficiaries often turn to the courts to resolve the dispute, ending up in litigation that can be very contentious and very expensive.”

Anderson said, in many cases such as these, families turn to a forensic accounting expert to analyze the management and administration of the trust or estate and to account for the assets and transactions.

“Perhaps one or more beneficiaries, who often are siblings or other relatives, believe the fiduciary (trustee or executor) is mishandling the trust or estate’s finances, is improperly taking funds from the trust or estate, or has improperly or unevenly distributed assets or income of the trust or estate.

“A forensic accounting expert has no stake in the matter and is not a family member.  He or she is concerned only with the facts of the matter at hand,” said Anderson, who provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  “As a result, both the beneficiaries and the fiduciary can be confident that the forensic accountant’s report will be independent, fair and unbiased.  Engaging a forensic accounting expert to settle the conflict is less contentious and less expensive.”

Anderson said a forensic accountant’s report typically identifies the specific documents that govern the administration of the trust or estate and cites specific passages from those documents regarding management of assets, distribution of funds, payment of fees to and expenses of the fiduciary, and related matters.  The report identifies the period examined, provides a schedule of assets of the trust or estate at both the beginning and end of the period, and lays out (in either detail or summary form) the transactions of the trust or estate.

Anderson, a forensic accounting expert in Philadelphia and the Delaware Valley, said the report outlines the forensic accountant’s findings regarding the fiduciary’s management of the trust or estate relative to the trust documents, and whether any transactions conflict with the governing documents.  The forensic accountant will review the report with the beneficiaries and the fiduciary and answer any questions regarding the findings.

While the cost of engaging a forensic accounting expert to analyze the handling of a trust or estate is usually significantly less than the cost of actual or threatened litigation, it is the lessening or neutralizing of the emotional aspects of the dispute that can be even more appealing to families.

“A forensic accountant’s involvement reduces the contentiousness,” Anderson said.  “Family members tend to acknowledge that the dispute is in the hands of a professional whose independent analysis will bring peace of mind to everyone involved.  The forensic accountant is, in effect, the ultimate arbitrator we grew up with.  It’s the next best thing to Mom and Dad.”

Anderson recommends that beneficiaries and fiduciaries engage the services of a forensic accounting expert at the first sign of a dispute — before the matter escalates and family relationships are destroyed.

“Don’t let suspicions of mismanagement fester until things have gotten so bad that there is no hope of repairing the relationship,” said Anderson, whose company offers a full range of forensic accounting services in Philadelphia and the Delaware Valley.  “Family is important.  Bring in a third party as soon as a conflict arises.”

If you require 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 with more than 30 years of experience in financial and operational leadership positions. He is a Certified Public Accountant, a Certified Fraud Examiner, and a Certified Valuation Analyst.

Part Five: Taking a Closer Look at Business Valuation

Posted by & filed under Blog Articles, Business Valuation, Company News, Marital Dissolution.

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 last 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 to assess more accurately 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 determining 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.

Part Four: Taking a Closer Look at Business Valuation

Posted by & filed under Blog Articles, Business Valuation, Company News, Forensic Accounting, Fraud, Fraud Deterrence, Marital Dissolution.

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,” Anderson said, “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 sales 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 an 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 “Taking a Closer Look at 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.

Part Three: Taking a Closer Look at Business Valuation

Posted by & filed under Blog Articles, Business Valuation, Company News, Forensic Accounting, Fraud, Fraud Deterrence, Marital Dissolution.

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, Anderson said, the business valuation expert can begin to analyze the value of the business under each of the different valuation approaches and methods.

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.

Part Two: Taking a Closer Look at Business Valuation

Posted by & filed under Blog Articles, Business Valuation, Company News, Forensic Accounting, Fraud, Fraud Deterrence, Marital Dissolution.

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.”

Earlier in 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.

Part One: Taking a Closer Look at Business Valuation

Posted by & filed under Blog Articles, Business Valuation, Company News, Forensic Accounting, Fraud, Fraud Deterrence, Marital Dissolution.

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,” he continued. “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 several 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 “Part Two: Taking a Closer Look at Business Valuation:” Determining the premise of value, the type of transactional circumstances that underlie 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.

Despite Being Legal, Cryptocurrency Transactions Can Still Carry Risk

Posted by & filed under Blog Articles, Business Valuation, Company News, Forensic Accounting, Fraud, Fraud Deterrence.

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

In my previous blogs on cryptocurrency, I discussed the risks involved with Bitcoin and other cryptocurrencies as well as the increased risks of hacking attacks against digital wallets, private keys, and exchanges.

In the past few years, cryptocurrencies have become more popular than ever.  In fact, as of today, cryptocurrency transactions are considered legal in most countries in the world.  Additionally, the financial community has gotten on board with cryptocurrencies.  Cryptocurrencies can even be used for retirement investments including IRAs, Roth IRAs, and certain 401-Ks.

Currently, the American Red Cross, UNICEF, the Rainforest Foundation, and the UN World Food Program accept donations in cryptocurrency.  Other charities also are exploring accepting cryptocurrency donations.

Notwithstanding the above, risks still abound with cryptocurrencies.  On November 11, 2022, FTX, a prominent cryptocurrency exchange, filed for bankruptcy.  This, in turn, has led BlockFi, a lender of cryptocurrency-backed loans, to also file for bankruptcy.  These filings have devastated the cryptocurrency markets.  Additionally, these filings have led to increased scrutiny of cryptocurrencies by Congress and US regulatory agencies.  This scrutiny is likely to lead to further regulations.

Other risks include:

  • Cryptocurrencies are still subject to extreme price swings, making them risky investments. For example, this year, Bitcoin’s price has fallen from $46,310 on January 1, 2022, to $16,928 as of December 1, 2022 (a loss of 63.4 percent in value).  Ethereum, another popular cryptocurrency has fallen from $3,689 on January 1, 2022, to $1,276 as of December 1, 2022 (a loss of 65.4 percent).
  • Digital wallets, private keys, and exchanges are still subject to hacking attacks. Binance, another cryptocurrency exchange, just announced it is freezing withdrawals of certain cryptocurrencies because of suspected hacking.
  • Commissions and fees for investing in and cashing out from cryptocurrencies are still significant. Additionally, there may be withdrawal limits for cashing out.

Gains and losses from cryptocurrency transactions must be reported on your Federal and other income tax returns.  Additionally, the Infrastructure Investment and Jobs Act, passed in November 2021, added certain reporting requirements.  Beginning in 2023, cryptocurrency exchanges and other transaction facilitators will have to track and report on their customer’s cryptocurrency transactions (similar to what your mutual funds and brokers/investment advisers currently do for securities transactions).

Also, starting in 2024, anyone receiving more than $10,000 in cryptocurrency for a product or service will have to report identifying details about the customer (including social security number) just as they currently are required to do for cash transactions over $10,000.  A check box has also been added to Federal income tax returns requiring the taxpayer to declare whether they’ve transacted or had a financial interest in a virtual currency.

Finally, Congress and the Biden administration have been examining the possibility of closing the “wash sale” loophole for cryptocurrencies which currently allows a taxpayer to take a write-off of a loss even if they buy another cryptocurrency within 30 days of a sale.

I will continue to monitor cryptocurrencies and keep you updated.

If you require any 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 with more than 30 years of experience in financial and operational leadership positions. He is a Certified Public Accountant, a Certified Fraud Examiner, and a Certified Valuation Analyst. Anderson also has served as a divorce accountant or marital dissolution accountant in Philadelphia and the Delaware Valley.

Business Valuation During a Divorce Can Be Complicated by Cash Transactions

Posted by & filed under Blog Articles, Business Valuation, Company News, Forensic Accounting, Marital Dissolution.

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

The decision to end a marriage is a messy affair that becomes undoubtedly more complicated when the division of property includes a business that must be valued; the situation becomes even trickier when claims of unreported cash transactions taking place in that business are involved.

In these cases, determining a fair value for the business is best left in the hands of a forensic accounting expert who has experience serving as a marital dissolution accountant and a business valuation expert.

“The issues that have to be considered in a business valuation during divorce proceedings are complex and numerous,” said David Anderson, principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides marital dissolution and business valuation services in Philadelphia and the Delaware Valley. Such issues can be particularly thorny, he emphasized, when the business in question may or may not have had unreported cash sales.

The overall valuation process, he said, “usually begins in an educational vein as the forensic accountant explains to the spouses and their attorneys how a forensic accounting expert addresses valuation issues in a divorce.”

One key business valuation issue which arises repeatedly in marital dissolutions, said Anderson, a Certified Valuation Analyst and marital dissolution accountant in Philadelphia and the Delaware Valley is the presence and impact of unreported cash sales.

During divorce proceedings, an out-spouse often will tell the divorce accountant the in-spouse’s business has unreported cash sales, explained Anderson, a divorce accountant and business valuation expert who provides a full range of forensic accounting services in Philadelphia and the Delaware Valley. The forensic accountant must then determine if the claim is true, and, if so, uncover the amount of the unreported sales.

This task is accomplished by performing a variety of analyses, including

  • Investigating deposits into the in-spouse’s bank and investment accounts to determine how many of the deposits were cash;
  • Analyzing the gross margin of the business (sales less the cost of sales) and comparing that gross margin to industry averages; and
  • Searching for missing invoice or receipt numbers (very often the in-spouse will complete an invoice or receipt for a cash sale, but not record it on the books of the business).

Other specific analyses also may be required depending on the type of business, said Anderson, a Certified Valuation Analyst forensic accounting expert in Philadelphia and the Delaware Valley. These analyses will allow a forensic accountant to confirm or deny the out-spouse’s claim, and, if confirmed, estimate the amount of the unrecorded cash sales that need to be added to the business’ revenues, he said.

“I once had a case in which the out-spouse told me her husband kept cash from unrecorded sales in his dresser at home,” recalled Anderson, a business valuation expert whose company offers a full range of forensic accounting services in Philadelphia and the Delaware Valley. “I actually went to the home and counted the cash in the dresser as part of my forensic investigation.”

If you need a marital dissolution accountant 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 with more than 30 years of experience in financial and operational leadership positions. He is a Certified Public Accountant, a Certified Fraud Examiner, and a Certified Valuation Analyst. Anderson also has served as a divorce accountant or marital dissolution accountant in Philadelphia and the Delaware Valley.

Independent Expert Witness Puts Education, Experience on Your Side

Posted by & filed under Blog Articles, Business Valuation, Company News, Expert Witness, Forensic Accounting, Fraud, Fraud Deterrence.

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.

Expert witnesses who are called to testify in litigation are not – contrary to what some people believe – supposed to be advocates for the side that hired them but should serve as independent experts applying their education and experience to the matter.

It should, instead, be the client’s attorney who serves as the advocate for his or her client, 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.

Forensic accountants, business valuators, and CPAs engaged as expert witnesses are subject to professional standards that require them to maintain their independence (there are some exceptions, such as those related to preparation of tax returns). Additionally, expert witnesses also may be required by certain government regulations to maintain their independence.

In discussing independence, Anderson, a Certified Fraud Examiner who recommends every organization enact a comprehensive fraud deterrence program created by an experienced firm that provides forensic accounting services in Philadelphia and the Delaware Valley, said the professions identify two sub-categories of independence:

  • Independence in fact, and
  • Independence in appearance.

Independence in fact refers to the expert’s mental attitude regarding the matter. It most often reveals itself in the expert’s reports and/or testimony. It should not matter which side has engaged the expert. The expert’s conclusions should be the same (subject to certain assumptions).

However, the expert’s independence could be called into question if:

  • The expert has made certain assumptions (at either the request of the client or the attorney) that clearly are unreasonable, and which benefit the side that engaged him or her. For example, if the expert has assumed a mature business would have been able to grow its revenues at a 20 percent rate solely from its existing products for each of the next 10 years or has assumed employees would accept a 50 percent wage decrease for the next ten years.
  • The expert asserts, without providing any corroborating evidence, certain questionable actions of the side that engaged him or her were reasonable. For example, testifying that certain funds improperly taken by an employee without authorization were advances on his or her inheritance because the employee expected to eventually inherit the business.

Independence in appearance, said Certified Fraud Examiner Anderson, refers to how an uninterested third party might view the expert’s independence considering certain facts. For example:

  • Does the expert have a financial stake in the side that engaged him or her?
  • Does the expert have a familial relationship with anyone on the side that engaged him or her?
  • Is the expert currently performing work for the attorney on another matter or does the expert have an ongoing working relationship with client that engaged him or her?
  • Is the expert owed money by the side that engaged him or her? If so, is it possible that the expert’s report or testimony could be affected by the potential of non-payment in the event the client does not like his or her conclusions or testimony? This is one of the reasons Anderson said he requires upfront retainers and payment in full prior to releasing a draft report or testifying.
  • Does the expert have, or has the expert had, a past adverse relationship with one or more of the parties or attorneys on the opposing side?
  • Has the expert agreed to make certain changes to his or her report or proposed testimony due to pressure or specific direction from either the attorney or the client? This also touches on the concept of making unreasonable assumptions. A recent prominent Federal Tax Court case – Exelon Corp v. Commissioner – was lost, in part, to the expert doing just that.
  • Is most of the expert’s work performed for either plaintiffs or defendants – the so-called “hired gun” – and not a balance of both?

Independence is a critical aspect of being an expert witness. The decider of fact – whether a judge, jury, or arbitrator – often will consider the expert’s independence in deciding on the credibility of the expert. As a result, expert witnesses must be independent in both fact and appearance.

If you engage in, or are anticipating, a legal proceeding, either as a plaintiff or defendant, make sure you have an expert witness who truly is independent. David Anderson is a Certified Fraud Examiner with experience providing forensic accounting services in Philadelphia and the Delaware Valley.

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.