Welcome to ourSummer 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.
Expert Update
We are pleased to announce that Ray Dunkle has become the first business valuator practicing out of
Medina,
Portage
, Starkand
Summit
Counties
to earn the prestigious Accredited Senior Appraiser (ASA) designation for his expertise in business valuations. Additionally, in May, Ray was appointed by Auditor of State Mary Taylor as an advisor to her Special Investigations Unit.
IN THE EYE OF THE BEHOLDER Using Financial Benchmarking To Minimize The Subjectivity Of Business Valuations
[This article is intended forusers of business valuations. It allows an understanding of how subjectivity can be minimized in a valuation.]
In 2006, James Hitchner published the 2nd edition of his book Financial Valuation, Application and Models. In spite of its ground-breaking nature, page one notes the obvious: Valuation has many subjective factors, and this leads to many differences of opinion. It is true after years of improved training, established credentials and refined financial modeling, business valuators still often do not see eye to eye. But, benchmarking can better align our vision.
The use of benchmarking is powerful because it allows the valuator to objectively identify areas of strength and weakness in a business. At times, these strengths and weaknesses are so nuanced that a simple visual review of historical financial statements, and even discussions with management, may not identify them. This, in turn, may lead to the misidentification of the causal effects of a businesss performance. Through the benchmarking of ratios and historical trends, valuators can more appropriately identify and adjust for drivers of value.
Analyses ofratiosallow valuators to assess operational and financial characteristics of the subject entity. By comparing a business against industry norms from recognized credible sources such as the Risk Management Association (formerly Robert Morris Associates) and Integra, the valuator is able see a businesss strengths and weaknesses versus its competition. For example, leverage ratios may identify opportunities for increased value. Borrowings below industry norms may identify opportunities for increased inexpensive debt financing. Increased debt financing leads to a lower weighted average cost of capital, which, in some instances, results in higher values.
Liquidity ratios also may identify significant adjustments to value. Such ratios measure an entitys ability to meet financial obligations. Ratios falling significantly below industry norms may identify weaknesses within the balance sheet. These weaknesses can result in direct reductions to calculated values due to asset shortages and/or borrowing needs. Other ratios, such as profitability and activity ratios, can also be considered to identify a companys strengths and weaknesses.
Furthermore, strengths and weaknesses may be identified via historical benchmarking. Under this approach, the valuator seeks to analyze the subjects current performance versus its past performance. This approach, where historical results are compared in both numerical and percentage terms, allows the valuator to identify trends in revenues, cost containment and profitability. These trends can then be investigated and understood. Historical benchmarking also identifies non-recurring events and indications of possible future events. These factors can have a substantial impact on value. For example, non-recurring events such as one-time litigation settlements, isolated workers compensation refunds, gains or losses on the disposition of property and equipment, among many others, can result in misleading financial results. By lining up and comparing year to year results, unusual circumstances are more readily determinable. Once determined, such unusual items can be accounted for to avoid inappropriate adjustments to value.
There is truth to the belief that business valuation contains aspects of both art and science. To this end, I.R.S. Revenue Ruling 59-60 recognizes that often an appraiser will find wide differences of opinion as to the fair market value of a particular stock. Through the thoughtful use of benchmarking, appraisers are able to apply common methodologies in order to identify items which impact value. While such common methodologies may not lead to a common vision, they will result in more objective conclusions.
UNCLAIMED FUNDS Fraud of the Forgotten
[This article is intended for professionals wanting awareness of a little-discussed, yet significant corporate fraud risk.]
Unclaimed property, sometimes referred to as forgotten money, is an area of high risk for fraud. Such funds can be stolen by employees or a company itself by purposely writing off abandoned or unclaimed property. Unclaimed property exists in companies in the form of rebates, bank accounts, money orders, insurance proceeds, utility deposits and unredeemed gift cards to name a few. Beware: every state has unclaimed property laws requiring companies to find the individuals who are owed property or to report those funds to the state. A company that fails to file the proper reports is not only breaking state law, but could also be violating rules that regulate financial accounting.
It is estimated that less than 20 percent of
U.S.
companies are in compliance with their states unclaimed property laws. Let me repeat: less than 20 percent! This equates to significant corporate exposure.
Obviously, this exposure can be avoided by complying with existing laws. The purpose of the state lawsis to:
Protect the interests and property rights of the lost owner,
Relieve the holders from the expense and liability associated with the property, and
Ensure that any economic windfalls benefit the public, not an individual holder.
To ensure compliance, and minimize the likelihood of fraud, certain procedures should be performed by the holder of the unclaimed property. Generally, these procedures are to:
Perform due diligence,
File mandated reports,
Remit property to the state,
Maintain copies of the reports and supporting documentation for a certain length of time, and
Protect funds until reported and transferred to the state.
No one industry is exempt from fraud related to these notoriously unmanaged accounts and these simple procedures can significantly minimize the risk. With this being said, it is extremely important to implement internal controls to safeguard a company against such fraud. For example, companies should identify all potential unclaimed funds liabilities, be cognizant of the unclaimed property laws of each state in which the company conducts business, develop and maintain detailed processes and procedures for tracking and reporting unclaimed property, and thoroughly test these internal controls both internally and externally through the use of outside specialists such as CPAs or Certified Fraud Examiners. A company may also consider forming an unclaimed property committee that would be responsible for compliance.
Implementing these procedures can be a life-saver. During unclaimed property examinations, it is common for state administrators to request a copy of the company's written policies and procedures as well as copies of the company's unclaimed property reports filed to the state in order to check that dollar amounts match on all reports. If these dollar amounts do not match as expected, this could be a signal to the state administrator that unclaimed property fraud may be occurring.
Simple steps such as the ones listed above should help avoid risks associated with unclaimed property fraud. With more companies better controlling this tempting source of funds, unclaimed property may no longer be considered the "forgotten money."
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.
