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Legal News: The Legal Intelligencer Blog
Normalization of Income: Where Business Valuation Meets Forensic Accounting, Part 2
By Brian Harris
By Terry Silver
Special to the Legal
Please see Part 1 of this article, published Nov. 30, 2011, for background to Part 2.
To value a closely held company, the valuator usually employs forensic accounting skills, such as keen interviewing techniques, the determination of whom to interview and understanding that often, listening is more important than speaking. Adept interview skills will lead to the extraction of useful information to be used in the business valuation. During a range of interviews of parties related to the matter, the valuator can amalgamate the gathered information, which is then used to direct and prioritize the continuing stages of the valuation and forensic process. Productive interview questions are the ones probing and phrased to produce narrative responses - not a simple yes or no.
A good interviewer uses the information obtained to develop a more specific line of questioning. The amount of useful information I usually obtain via the interview process has been significant. For example, during an interview with a financial controller, he admitted to keeping two sets of books! By using patient, thoughtful and organized questions, surprising information can often be obtained. At a minimum, a productive interview will provide information essential for the normalization aspects of the business valuation, and at most, will disclose major information, which can significantly influence the valuation conclusion.
Ultimately, it is the useful data that the forensic aspects of a valuation engagement must produce. The valuator will always review books and records in the course of the engagement. This involves an analysis of the records to gather data in order to determine whether and what normalization adjustments should be made. Many companies use accounting software (like Quickbooks), which in this process can be examined to extract relevant valuation data. For a company whose database is manageable, the manual review of its records is common. For those companies whose databases are too large to render this application manageable, automated data mining is preferable and most likely necessary.
At Citrin Cooperman, we utilize an automated data mining software called IDEA, which facilitates the targeting of specific data within a database. After the review of financial records such as financial statements, tax returns, etc., and appropriate interviews, the valuator will assess what data is desired. The target data is entered into IDEA, and the software searches the company database for the requested data. For example, in a recent investigation of a family-owned, multi-company organization, we were able to identify payments made from each company to all other companies in the group, as well as payments made to all family members, by integrating IDEA into the accounting software. This process was completed in no time! Using tools like IDEA to data mine makes it possible to identify useful information in an efficient, cost-effective manner.
Knowledge is king, especially in the forensic accounting process. The accuracy of your business valuation will be influenced by the information obtained via the forensic analysis process.
Terry Silver is a Certified Public Accountant, Certified Valuation Analyst and certified in financial forensics for Citrin Cooperman, an accounting, tax and business consulting firm in Philadelphia, where he is a partner with more than 33 years of experience as an accountant and auditor. He focuses his practice on business valuation and financial forensic services, expert testimony and matrimonial actions. He can be reached at firstname.lastname@example.org or 215-545-4800.
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