It’s not your imagination. In the periods just before a divorce or business ownership dispute, it’s so common for spouses and business owners to discover unexpected drops in reported profits, that I’ve coined the term “Pre-Dispute Business Downturn Syndrome” (or PBDS for short) to describe it.
During the last 20+ years, I have performed more than 1,000 business valuations in marital dissolutions and business divorces, and I have noted a number of ways that PBDS shows up in advance of an ownership dispute.
5 Issues That Might Be PBDS
1. Manipulating Cash Basis Businesses
Businesses that report their performance on the cash basis of accounting (e.g., many professional practices), can leave cash and revenues unrecorded until the next year and expenses can be accelerated into the current year, thus decreasing profits.
Paying all bills by the end of the year for a cash-basis taxpayer may be characterized as good income tax planning. However, deferring revenues by holding off on normal billing practices in the last month of the year can cross the line from good income tax planning into the realm of the PBDS.
2. Accounting Estimate Inconsistencies
Businesses using accrual accounting can also exhibit symptoms of PBDS. Estimates by company management are regularly required to apply accounting principles to develop financial statements, and they can be adjusted in ways that can reduce the value of a business.
For example, a construction contractor might be asked to estimate the percent complete of each of its in-process jobs. If a business partner or spouse was looking to reduce revenues and profits on a financial statement, however, they might back off on this reported percent, thus deferring revenues and gross profit from the current year to the next year.
3. Moving or Hiding Assets
Business assets can be sold, moved, or hidden. As an example, ahead of a marital dissolution or a business divorce, a spouse or business partner might create a new, undisclosed business entity and shift assets to this entity to remove them from a company’s balance sheet – thereby driving down the value of the company.
4. Keep an Eye on the Next Accounting Period
Time can deliver important clues about whether PBDS has occurred. In the first two examples above, profits are only deferred. The next accounting period, however, often shows an atypical increase in company profit.
5. PBDS Might Be a Symptom of a More Serious Disease
One might argue that the first two examples above could be characterized as the aggressive application, or misapplication, of accounting principles. Yet they could also indicate the existence of a more serious issue. Whether the business is operating on an accrual or cash basis, manipulating the timing of revenues and expenses may be a sign of fraudulent financial reporting or of the dissipation of a marital or business asset. And shifting assets to a previously undisclosed entity may be an indication of fraud.
How Do You Diagnose PBDS?
The symptoms of PBDS are often recognizable in the due diligence and analysis a business appraiser undertakes. That is why it is to your benefit to hire an experienced, competent business appraiser to assist you with a business valuation in a marital dissolution or business divorce. In situations where assets are being transferred, hiring a forensic accountant may be your best bet.
Often, business appraisers and forensic accountants work together on cases involving a business exhibiting symptoms of PBDS. A qualified team of experts can confirm or alleviate your suspicions about the value of a business and help guide you through your divorce or ownership dispute. Visit our litigated business valuation services to learn more about these services or contact us for a consultation.