12 May

The Business Lifestyle Analysis

iStock_000019355019XSmallThis article was originally printed in the ABA Section of Family Law eNewsletter, April 2014.

Closely held businesses present special challenges in the family law setting. Typically, only one spouse is actively involved in the business. Therefore, not only does the spouse control the family’s finances, he or she also controls all of the records of the business. When a spouse is attempting to quantify the income from the business or the value of the business, the spouse who works actively in the business can purposely (and often very effectively) obstruct attempts to get accurate and complete data.

Certain types of businesses, such as restaurants and retail stores, can be prone to manipulation because they have so many cash transactions. Construction companies, real estate ventures, and auto dealerships are notorious for “creative” bookkeeping. Professional service providers, such as doctors, dentists, and attorneys are at risk for financial maneuvering because it is so difficult to verify the amount of professional services actually provided to patients or clients.

Any business that is closely held and has finances that are easily manipulated by the owner is at risk. If this happens, the “out” spouse is left looking for alternatives to get to the bottom of the finances. Techniques used in a personal lifestyle analysis can also be applied to businesses to ferret out the truth about the money.

Business Records
The most common business documents produced in family law cases include ownership records, income tax returns, financial statements, budgets, valuations or appraisals, and lists of financial accounts. It may be necessary to dig into the detailed accounting records of the business, including the general ledger and supporting documentation such as bank statements, to determine whether:

  • A spouse has used business funds to pay personal expenses
  • Income and expenses of the company are legitimate or manipulated
  • Key customers or vendors are engaging in legitimate transactions with the company
  • Any large one-time expenses were incurred (which may need to be adjusted when analyzing the numbers in a divorce case)
  • Assets or liabilities of the company have been manipulated
  • Write-offs or adjustments to the books are appropriate
  • Future income and expenses can be estimated

Analyzing Income
A company’s current income should be compared to historical income, and the reasons for any changes over time should be determined. It is not unusual for the revenue of a closely held business to drop dramatically around the time of the filing of a family law case. The spouse who is active in the business may attempt to make it appear as if the business is failing. A failing business has a lower value to be divided between the spouses, and a failing business also means there is less income from which support can be paid.

If income has gone down after the filing of the family law action, related expenses should be evaluated to determine if they have decreased proportionately. This is discussed in more detail in the next section of this chapter.

An analysis of revenue by customer should be completed to determine if any long-term customers have disappeared from the accounting records. It is possible that those customers are still purchasing from the company, but the revenue is not being recorded in the financial statements.

Cash businesses can be especially difficult to investigate. A few of the more common techniques for verifying income in cash intensive businesses include:

  • Research the normal mark-up or profitability of the product or service sold, and determine how the figures of the company compare.
  • Identify expenses that move in a predictable fashion with income, and see if there are any anomalies across years.
  • Find a documented expense that could prove or disprove income. For example, a laundromat reports a substantial decrease in income after the filing of divorce. Water bills show that the water usage has not decreased. This may tend to show that income is intentionally underreported.
  • Examine payroll records to determine if staffing has been reduced following a claimed decrease in income.

Analyzing Expenses
There is a tendency to gloss over business expenses and assume that they are legitimately incurred in the normal course of business. This is not necessarily the case, and inflated business expenses can reduce business profits. This would cause a valuation of the business to be lower than it ought to be, which could negatively affect a spouse during divorce.

It is not uncommon for a business owner to pay personal expenses with business funds, and this is discussed in greater detail in the next section of this chapter. The forensic accountant should consider whether expenses have a true business purpose. For example, the owner may secretly create an entity that receives substantial payments from the original company for “consulting.” This may be an attempt to reduce the profitability of the original company, which can affect business valuation and the division of assets.

The financial expert may ultimately adjust several items in the business financial statements to bring the numbers in line with those of a company with financial statements not subject to the whims of an owner. Even small adjustments to several line items could collectively alter the financial picture of the company.

Looking For Red Flags
One of the most basic cues that the numbers of a business have been manipulated is an inconsistency between documents. It is important for the forensic accountant to apply professional skepticism to documents received, constantly questioning whether the documents and number are authentic or manipulated.

The financial records should not only be evaluated in terms of the numbers themselves. They should also be evaluated relative to the quality. Has the quality and completeness of financial information changed over time? Is there any explanation for the change in the quality of financial information? Could a change in the quality of information be related to a manipulation of the financial condition of the company?

There are many ways that the finances of a business can be obscured and manipulated. It is important to have an experienced financial expert dig into the accounting records to determine whether any red flags of fraud exist. While it may be difficult to prove beyond a shadow of a doubt that the books were manipulated, the competent accounting expert may find multiple red flags that all indicate deception ultimately persuade the court that there is more to the numbers than meets the eye.

Tracy L. Coenen, CPA, CFF is a forensic accountant and fraud investigator with Sequence Inc. She specializes in cases of embezzlement, financial statement fraud, white collar crime, securities fraud, and family law. She can be reached at 312.498.3661 or [email protected]

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