In the original 1963 Pink Panther movie, the largest diamond in the world, named the Pink Panther, is stolen from Princess Dala. Then begins Inspector Jacques Clouseau’s never-ending quest to recover the jewel. In this situation, Princess Dala needs two professionals; a jewelry appraiser to appraise the value of the Pink Panther for the insurance adjuster, and a French detective to recover the stolen diamond. An important distinction should be apparent, a jewelry appraiser is not a detective and a detective is not a jewelry appraiser. Similarly, in a business valuation the client should understand that a business valuator in not a forensic accountant and a forensic accountant is not a business valuator.
Business valuation is the act or process of determining the value of a business enterprise or ownership interest therein.i A business valuator is someone certified to perform business valuations. Forensic Accounting is the use of accounting skills to investigate fraud or embezzlement and to analyze financial information for use in legal proceedings.ii A forensic accountant is a CPA, accountant, or other qualified person that may or may not be certified in forensic accounting. A professional may be both, a certified business valuator and a forensic accountant, but the jobs are different.
Sometimes clients believe that the business valuator is also a forensic accountant. However, the process of determining the value of a business does not include auditing the business’ financial records or performing forensic accounting. Generally, the business valuator will accept the Company’s tax returns, financial statements, and other financial records at face value without verification. In fact, most business valuation reports will contain language similar to the following:
Financial statements and other related information provided by the Company or its representatives, in the course of this engagement, have been accepted without any verification as fully and correctly reflecting the enterprise’s business conditions and operating results for the respective periods, except as specifically noted herein. The Business Valuator has not audited, reviewed, or compiled the financial information provided and, accordingly, expresses no audit opinion or any other form of assurance on this information.
Discovering hidden assets, unreported income, money, or personal expenses is not within the scope of a business valuation engagement. This is the job of the forensic accountant. Forensic accounting engagements are very time consuming and expensive. The forensic accountant must exam, track, and document huge volumes of bank statements, credit card statements, financial records, and other documents.
The insurance adjuster for the Pink Panther diamond would certainly like Inspector Clouseau to recover the gem and alleviate his covering the loss. Likewise, a business valuator would like the forensic accountant to uncover unreported income, hidden assets, and personal expenses related to the business to assist in determining an accurate value of the business. However, some clients want a forensic accounting conducted without a clear purpose. The client may be angry, frustrated, and wanting to know everything simply for the sake of an “Aha Moment.” This can lead to wasted time and money. If forensic accounting is being considered for the purpose of valuing a business, first consult with your business valuator, or have your business valuator work with your forensic accountant, so the accountant uncovers the information needed for the business valuation.
Consider this example. The President of a company believes that the sales revenues are understated, which lowers the value of the business. He suspects the Vice President of Sales is skimming off and not reporting certain sales revenues. To estimate the missing sales will require a forensic accountant to piece together product purchases, inventory, cost of goods sold, and sales. The President is very upset because the VP is an old golfing buddy. The President hires a forensic account to find every personal lunch charge, every personal cell call, and any other personal charges by the VP. The forensic accountant combs through reams of credit card and cell phone statements. The bill is $25K, but there is no information useful to the business valuator to estimate the true sales revenues of the company. Time and money wasted.
Forensic accounting is a very effective tool in many contexts, including business valuation. However, always focus on the purpose. You do not want to waste time and money on Inspector Clouseau’s never-ending quest for the Pink Panther.