04 Feb

Evaluating the Income of a Business

It’s not unusual to want to confirm the income of a business in litigation. Whether it’s a divorce, a business breakup, a wage claim, or other matter that involves accurately reporting business income, it may be necessary to attempt to verify that income.

I frequently work withe clients who claim that the reported income of a business is artificially low. For example, a spouse who runs a small business may make the income of the business look lower than reality in order to reduce spousal support payments and/or reduce the value of the business for the division of assets.

In a business divorce, a party may falsely report lower income to reduce the value of the business and therefore the amount necessary to buy out the other owner(s). A wage claim involving commissions and bonuses that relate to sales volumes may need a verification of income if the company is accused of underreporting sales.

How do we do this?

A company’s current income should be compared to historical income, and the reasons for any changes over time should be determined. If there have been any substantial one-time sales that will not recur (or will only recur infrequently), that should be considered when projecting future income.

It is not unusual for the revenue of a closely held business to drop dramatically around the time of the filing of lawsuit. A person who is active in the business may attempt to make it appear as if the business is failing or less successful than it really is. A failing business has a lower value to be divided between parties, and a failing business also means there is less to be paid out when there is a payment to be made that is based on income.

The financial expert should consider whether the income of the company has fallen because a new subsidiary or related third party has been created to receive the income. This could be an attempt to shield income or otherwise deprive someone of a share of assets or income.

If income has gone down after the filing of a lawsuit, related expenses should be evaluated to determine if they have decreased proportionately. Often there are expenses that move in line with income (ex. as income goes up, a certain expense goes up proportionately). This may be an effective way to evaluate reported income.

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 indicate that income is intentionally underreported.
    • Shipping records from a private company such as UPS or FedEx may show that the volume of packages shipped by a business has not decreased, even though income is allegedly down.
    • Purchases of alcohol for a restaurant or bar may show no changes in quantities, despite the business reporting substantially reduced income.
  • Examine payroll records to determine if staffing has been reduced following a claimed decrease in income.

Proving that income has been underreported intentionally is not easy. But the more data points that show suspicious things, the more likely you can make your case.

One thought on “Evaluating the Income of a Business

  1. OFFHAND

    An evalustion of income from business spoken of , could, as indicated, arise also in regard to an ongoing business carried on by any legal or other entity, coming within the leagal concept of , – PERSON;; and as specialy defined for taxation in the IT Act.

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    For a dilation, also refer the comment on FB @ https://www.facebook.com/swaminathanv3/posts/2044972032245739

    For proper accounting in the Books , likewise for taxation, the consulting or advising professiinals, might have to keep in focus, apart from the prescribed STANDARDS, – Indian and Foreign,- the lately introduced Tax Accounting Standards prescrribed and requiring compliance.

    courtyesy

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