Fraud — whether it’s occupational or external — doesn’t just cause immediate financial losses. Your organization’s long-term value can also be reduced. For example, it could lower the price when you sell or limit the amount of capital you can raise via lenders and investors. Even poor internal controls can reduce your business’ worth. Here’s a brief overview of how valuation professionals assess fraud risk.
Presence Of Internal Controls
Business value is a function of risk and return, and one critical risk factor organizations face is fraud. Valuators conducting an appraisal might ask about an organization’s internal controls — its policies and procedures to protect assets and help ensure reliable financial statements. They often look for particular controls that have been proven to help prevent fraud, such as:
- Employee training programs
- Job rotation plans
- Mandatory time-off policies
- Regular inventory counts
- External auditing of financial statements
- Confidential fraud hotlines
- Surprise audits
Some businesses are more vulnerable to fraud than others. For example, the Association of Certified Fraud Examiners has found that banking and financial services, government, manufacturing, and health care organizations experience higher-than-average fraud rates. If your organization operates in a risky industry, a valuator might apply a higher discount rate when discounting future earnings or adjusting pricing multiples derived from comparable organizations. In addition, valuation professionals generally are more cautious with some types of engagements, such as shareholder disputes and divorces.
When Escalation Becomes Necessary
Valuation experts rely on financial statements to estimate value. When they analyze statements, they might unearth red flags of fraud. For example, a valuator may notice a disconnect between revenue growth and changes in key assets (such as receivables or inventory) or sudden changes in gross margin.
What if a valuator learns about or suspects fraud based on preliminary assessments of internal controls, financial statements, and other factors? The professional might suggest expanding the scope of the engagement. An escalation could include adding forensic accounting services offered by the valuator’s firm or, in the case of sole practitioners, a separate forensic accounting advisor.
Fraud specialists can help make adjustments to accurately value businesses. They can also help organizations build legal cases against fraud perpetrators, if necessary.
Arriving At A Valid Value
One important caveat: Valuation engagements aren’t designed to find fraud. So, if you’re concerned about illegal activities that could be underway or need to bolster internal controls, consider hiring a forensic accounting professional. If, on the other hand, you need to appraise your business’ value for a possible sale, loan application, public offering, shareholder dispute, marital dissolution, or other litigation, you’ll want to engage a qualified valuation professional. Contact us for more information.