Fraud — whether it’s occupational or external — doesn’t just cause immediate financial losses. It can also reduce your company’s long-term value. 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’s 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 companies face is fraud. Valuators conducting an appraisal might ask about a company’s internal controls — its policies and procedures to protect assets and 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, and
- 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 company operates in a risky industry, a valuator might apply a higher discount rate when discounting future earnings or adjusting pricing multiples derived from comparable companies. 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 companies 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, hire a forensic accounting specialist. If, on the other hand, you need to appraise your business’s 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.
Annette Benson, CPA, CFE and Partner comments,
“Fraud is more than just an immediate financial threat; it casts a long shadow on a business’s value, affecting its ability to attract buyers, lenders, or investors. Valuation professionals assess fraud risk by scrutinizing internal controls and identifying red flags in financial statements. Strong internal controls—such as mandatory time-off policies, external audits, and confidential fraud hotlines—not only mitigate fraud risk but also enhance a company’s credibility and long-term valuation. Businesses in high-risk industries should be especially vigilant, as the presence (or absence) of fraud prevention measures can directly influence valuation outcomes. While valuation engagements aren’t designed to uncover fraud, addressing concerns proactively with the help of forensic accounting specialists can safeguard both your operations and your business’s worth.”
Contact one of our experts at (888) 388-1040 if you have questions on your situation.
