Academic journal article
By Zipp, Alan
Journal of Accountancy , Vol. 178, No. 6
Computer software is great for running the numbers, but a business appraiser's own judgment is crucial to a successful effort.
Business valuation is among the hottest new services being offered by CPAs to clients buying or selling a company, going through a divorce, splitting up or merging a business, valuing stock in an employee stock ownership plan or preparing an estate or gift tax return. And, along with the new demand for business valuation services come software programs that may appear to make our job easier, faster and more consistent from one engagement to another. While technology is useful to appraisers, danger awaits the unwary.
Recently, a CPA spent two days on the witness stand being cross-examined about his "appraisal" of a business and the resulting report. In the end, it was revealed that the CPA had never appraised the business; he simply copied tax return information onto computer input sheets and mailed them to a computer service bureau in California. By return mall, the CPA received a complete report analyzing the business, comparing it with industry averages, discussing the economy and concluding that the business was worth over $1 million. After the CPA admitted neither he nor the computer company had ever visited the business, talked to management, examined the books or even identified the correct industry, the court summarily dismissed his report and his testimony as not credible. It was more than an embarrassment to the CPA: As a partner, he discredited his firm among the legal community from which it sought future engagements. He also charged his client $10,000 for services of highly questionable value. Could he be liable for malpractice?
Unfortunately, there is an even easier way to perform a business appraisal. Several software vendors offer programs that enable CPAs to produce reports simply by entering relevant business data. While computers can be valuable in all parts of a CPA practice, those who use any software without applying their own research and judgment to the engagement may suffer the same fate as the CPA discussed above.
MORE THAN CALCULATIONS
The computer is a marvelous tool when properly used. However, the potential for misuse is enormous and, sadly, quite prevalent. Too often, inexperienced appraisers and their clients believe that what comes out of a computer must be right because the computer did it. But when the moment of truth arrives and the report must be justified, the entire conclusion falls apart.
To make a credible business appraisal, the CPA must consider much more than the business's historical financial results. The most significant element of value lies not in where the business has been but, rather, where it can be expected to go. Historical results of operations can be a good indicator of expected future company earnings, but without more analysis and information there is no rational basis to expect the future to repeat the past.
For example, if a business owner was personally responsible for historical profitability--through personal business relationships, for example--how reasonable is it to use past results in forecasting profitability after the owner dies? Similarly, if the owner is retiring and selling out, should the buyer expect the historical earnings level to continue without the benefit of the seller's business contacts?
Many appraisers examine the five preceding years' financial information in making projections about a business's future, but the economy was different five years ago from the way it is today. In addition, won't changing technology affect future expectations? Doesn't the changing nature of competition have a bearing on future earnings projections? Today, a handful of nationally recognized chains spend enormous sums advertising one-hour lens crafting, lightweight glasses, no-line bifocals and a second pair at half price. What is the future of a local optician in light of the new competition? …