When going through a divorce, in is not uncommon for the parties to hire a valuation expert, often at the direction of their attorneys, to assist them with the process of dividing marital assets. This is especially true when one or both of the individuals involved have business ownership interests. As emotions can lead people to act “out of character”, doing things that they normally would not do, hidden income can become a major issue in these cases. In many cases, if one of the spouses owns a business, the other spouse might accuse them of earning more money than the financial records indicate.
Using forensic accounting, a valuation expert is often called upon to pursue the possibility of hidden income. In some cases, the spouse might try to hide the true income of a business by claiming more expenses than actually exist, delaying the recognition of new revenues, or hiding some of its assets.
It is also possible that the spouse who doesn’t own the business is making a charge without merit. After all, they do not necessarily have as intimate a knowledge of the business. In order to determine whether or not there are any grounds to the accusation, a valuation expert is often required.
Business owner-spouses serve themselves in two ways by understating their business income. First, if the business shows lesser earnings, the value of the business is lower. This means that a lesser amount will have to be shared with the non-business owner-spouse in the division of marital assets. In this way, the business owner-spouse can increase the amount of money that they keep in the divorce. Secondly, to the extent that business income factors into alimony and/or child support calculations, understated income decreases the business owner-spouse’s support payments.
Forensic Accounting Techniques used in Business Valuation
A business valuation expert can use a series of forensic accounting techniques to determine if missing income exists, and, if so, to what extent. The valuator must look beyond the financials in order to discover the business owner’s true financial picture.
One possibility that valuation analysts consider is that the business owner-spouse is hiding cash. In some cases, a business owner might either be paid directly in cash or have sole access to the company’s cash deposit box. In other cases, the business owner might have client direct their payments to other personal accounts. These circumstances make it easy for the business owner to hide income. Experts use a series of advanced techniques to determine if there is missing cash and how much of it has not been reported.
A valuator can start by requesting and reviewing all sources of cash to which the owner has access and all business and personal expenses. This makes it possible to track the money from where it came and for what it was used. If the valuation expert can show that the owner consistently spends more money than he/she earns, income is most likely being underreported.
If the business owner suddenly shows a higher net worth and there is not an apparent source for this added income, it is an indication that income from the business was understated. The net worth of the owner can be estimated using various methods such as real estate records, loan and credit card applications, bank statements, and brokerage statements.
The expert can also analyze bank deposits. In this method, the expert looks at income earned in the past by looking at bank deposits, including canceled checks and other transactions. By looking at undeposited receipts and sources of cash other than income, it is possible to reconstruct total income.
Another way the expert can detect hidden income is by looking for sudden changes in sales, expenses, or other figures. The valuator will often use an average of several years of revenues and expenses in order to make reasonable assumptions about normalized income.
Given the complexities and esoteric nature of these forensic and valuation techniques, it is vitally important to find the right team of valuation specialists to assist you.