We have talked about the fiduciary relationship between spouses during a divorce. In a fiduciary relationship, you are required to act in the best interests of the person you have the relationship with. As it pertains to a couple going through a divorce, this means that all assets and liabilities must be disclosed so a proper accounting may be done so the division of assets may be fair and equitable.
If one or both spouses own a business, the business must also be properly valued. For some businesses, especially cash businesses, finding the true value of the business can be difficult and require the assistance of a forensic accountant.
There are several methods that can be used to place value on the business. Original cost refers to the amount spent to either buy the business or for the initial start-up costs. Book Value is a method that simply totals the assets and subtracts the liabilities. Fair Market Value is how much the business may be sold for on the open market, and Liquidation Value is the amount the business could be sold for. Liquidation Value is generally lower than Fair Market Value since the primary goal of the sale is speed and expediency while a Fair Market sale could take time and be valued higher due to the potential for future profits.
Of the methods used in business valuation, book value is problematic, as the numbers in the books might not properly reflect the actual assets or liabilities of the business, especially in a cash business. The biggest concern for a cash business is the money that is pocketed without hitting books, leading to unreported income and the book value of the business being lower than it actually is.
While practices such as pocketing cash or putting personal expenses on the business might be widespread, these practices are both illegal (tax fraud, for one) and unethical as reporting the lower value of the business is effectively lying to the person to whom, as mentioned, you have a fiduciary responsibility.
It is common practice to bring in a forensic accountant to perform the business valuation. Forensic accountants look through the books and other details of the business to come to a true value of the business since even if you pocket the cash, there are other signs that point to the truth.
Let’s take the example of a coffee shop where much of the business is done in cash. According to the books, the owner might be reporting they are selling 100 cups of coffee per day, however, the expenses of the business show that the owner has been buying 100,000 cups for the business per year for several years. 100 cups per day for an entire year is 36,500 cups. The discrepancy between the number of cups reported sold and the number purchased do not coincide with each other, even taking into account cups that might be thrown out due to mistakes. Such a discrepancy might be made once or even twice, but when it happens for several years in a row, then questions will be asked.
When a business is involved in a divorce, the value of the business can be a significant portion of the marital assets to be considered when assets are distributed. While the books might tell one story as it pertains to the value of the business, the facts might tell a different story. As any accountant will tell you, you can make numbers say almost anything you want, but when you bring in all of the related facts to put the entire puzzle together, it is easy to see when the puzzle is missing pieces.