Welcome to our Fall issue of Valuation/Litigation Insights.Through this publication, our hope is to bring our friends in the business community original, internally prepared perspectives that are brief, meaningful and useful.With each article we identify our intended audience, allowing you to focus on what is relevant for your practice or business. Please let us know if there are any topics you would like to see addressed in future issues.
ETHICAL
LAPSES HARMING NONPROFITS
Recent Independent
Studies Uncover Disturbing Trends in the Nonprofit Sector
[This article is intended foradvisors working with and/or serving on
nonprofit Boards. It allows an awareness of damaging and avoidable trends.]
Recent independent studies by the ACFE (Association
of Certified Fraud Examiners) and the ERC (
EthicsResourceCenter) provide objective
indications that financial fraud is increasingly having a negative impact on
even the most altruistic organizations.These trends are dangerous not only because of their direct financial
impact but also because the corresponding appearance of low morals. Such appearance can lead to a deterioration
of public trust and a decrease in financial support.
The ERC, which is a nonprofit focusing on the
advancement of high ethical standards, noted in its most recent National Nonprofit Ethics Survey that Integrity
in the nonprofit sector is eroding.Misconduct is on the rise especially financial fraud. Its studies concluded that financial fraud is
higher in nonprofit organizations than in business or governmental
organizations.
The direct damages from this financial fraud
are significant. In the ACFEs 2008 Report to the Nation it is noted
that the average fraud occurring at a nonprofit had existed for 24 months
before it was detected. The average
damages for 39 victim organizations categorized as religious, charitable or
social services were $106,000 while 16 arts, entertainment and recreation
organizations were impacted by an average of $270,000. Overall, average damages for nonprofits of
all types were $109,000 per occurrence, a 9 percent increase over the previous
study two years prior. While disturbing,
this trend is not surprising since 8 percent of employees responding to the ERC
survey reported observing alteration of financial records, an increase from 5
percent just one year prior. As a result
of these negative trends, 19 percent of nonprofit employees reported believing
that their organization had become less ethical in the past five years as
compared to 11 percent of governmental employees and 7 percent of corporate
employees, according to the ERC.
There is
hope.
Based on
ERCs studies:
Well implemented programs have made
the difference where misconduct has remained low in the nonprofit sector. A near perfect result can be achieved. A well implemented program and a strong
ethical culture essentially eliminate misconduct
While the
risk of fraud can never be completely eliminated, much can be done to reduce it. For example, ERCs study found that 20
percent of respondents who did not report inappropriate activity did not speak
up because they did not know who to contact.Fifty percent did not speak up because they did not believe corrective
action would be taken. Simple, inexpensive steps such as employee training and
policy implementation could virtually eliminate these excuses.
The ACFEs
findings corroborate those of the ERC.According to the ACFE the implementation of anti-fraud controls appears
to have a measurable impact on an organizations exposure to fraud. When looking at 15 common anti-fraud
controls, the ACFE found in all instances that victim organizations having such
controls suffered significantly lower damages than those without the
controls. For example, average damages
at organizations having surprise audits were $70,000 while those without
surprise audits were $207,000. Likewise,
average damages at organizations having a fraud hotline were $64,000 while
those without a fraud hotline were $164,000.Perhaps most telling about the effectiveness of controls is found in the
fact that the only type of organization experiencing a decline in the overall
proportion of fraud cases was the only type of organization forced to
strengthen internal controls that is publicly traded organizations impacted
by Sarbanes-Oxley.
As concluded by the ERC, nonprofit leaders
and boards of directors need to:
oMake
no assumptions assess your organization and avoid the it wont happen here
mentality,
oImplement
an ethics and compliance program with high-level oversight,
oImplement
internal controls to prevent financial fraud, and
oGrow
an ethical culture that fits the organization.
In the end,
these reports serve to highlight two significant facts: 1) non-profit
organizations as a whole are doing a poor job of protecting their resources and
their reputations, and 2) solutions to these problems are effective, practical
and available.
If you are
interested in learning more about how you can implement preventative controls
in your organization, call or email Ray Dunkle at (330) 572-8046 or
.
NOT A PENNY LESS
[This article is
intended for those involved in the process of selling a business.]
Business owners often do not consider the value of their
business until it is time to sell or transition it to the next generation. To
ensure a high return on investment, preparing a business for sale is a process
that could take several years. Experts suggest that the typical business owner
should plan on preparing for a sale over a period of 5 7 years. In this article we will briefly discuss what
business owners can do to ensure that they receive full value for their
business.
Offering Price
Due to the number of buyers in the market, many are
approaching companies not currently for sale.This may entice some business owners to sell earlier than they had
expected. Often, valuation analysts are
engaged during the selling or buying process to assist in determining the
offering price or whether the price being offered is reasonable. At this point, sellers have lost much of their
ability to maximize the selling price and will be subject to the recent history
of their business.
Having a valuation done before a company goes to market can
be a good tool. The business owner will
have an idea of what the market will bear and will learn what drives the value
of the business. If this valuation is
prepared several years in advance, the seller will also have the opportunity to
improve on those drivers and increase the value.
Accuracy
When assisting clients in buying businesses, valuation
experts are frequently told that the seller has been overly aggressive in
expensing items. This often includes
expenses such as automobiles, travel, entertainment, and other miscellaneous
items. We are even told sometimes that
the seller has not reported all of their income! This causes a problem for the transaction - the financing
bank likely will not provide funding based on unreported profitability and, as
a result, available financing may not be sufficient to complete the deal. Beyond the obvious legal implications, it is
important that tax returns and financial statements reflect the true earnings
of the company.
Credibility
In trying to control costs, many small business owners look
to minimize their accounting fees. This
may include not having financial statements professionally prepared. Tax returns not prepared using Generally
Accepted Accounting Principles may not be sufficient for prospective buyers and
banks. The preparation of financial
statements by a reputable accounting firm instills confidence in a buyer
regarding the accurate reflection of a companys historical performance. To instill greater confidence in the
historical financial statements, sellers may also want to consider getting
audited financial statements. The portion of such costs beyond normal
accounting costs can be added back to cash flows when determining value and,
therefore, will not negatively impact the value of the business.
Past and Future
Performance
As well as reviewing the historical financial statements,
buyers are very interested in future estimates.If a company is going through significant growth or a major financial change,
a buyer will need to see projected financial statements. A few words of caution: be certain that
projections are based on substantiated data.Unsubstantiated hockey stick projections threaten a sellers
credibility and plant a seed of doubt in a buyers mind.
Due Diligence
Being prepared for due diligence will help complete the selling
process in a timely manner. Most buyers
ask for similar documents, so basic items should be prepared and ready to go
prior to putting the company on the market.The longer the transaction takes to complete, the more time the buyer
has to ask for a price reduction or back out completely. Furthermore, long periods of time can cause
sellers to become subject to industry and economic trends, of which they have
no control.
Selling a business can be an arduous task. Having several
years of accurate financial statements and an accredited valuation expert on
hand will not only save time, it may enhance the sellers return on investment. If you have questions regarding how you or
your client can be properly prepared, call a valuation expert today at (330)
864-6661.
Disclaimer: These articles are intended for our friends in the legal, banking and professional services community and merely reflect our observations. These articles should not be construed as legal counsel. Contact an attorney whenever legal advice is needed.
