What to consider when looking at the benefits of a cost segregation study

A cost segregation study is the process of identifying fixed assets and their costs and classifying these assets and costs to maximize federal income tax depreciation deductions.

It involves reclassifying some of a building’s costs presumed to be subject to a 39-year cost recovery life into shorter personal property or land improvements with a five or seven year rate of depreciation for personal property and/or a 15 year rate for land improvement projects.

“With engineer-based cost segregation, a building owner may depreciate a new or existing facility in the fastest allowable time, accelerating the owner’s tax depreciation and tax deduction and deferring income taxes,” says Lou Petro, senior manager at Cendrowski Corporate Advisors LLC.

Smart Business spoke with Petro regarding the benefits of performing a cost segregation study.

What facilities are available for a cost segregation study?

Cost segregation studies are economically viable for almost any commercial facility. The facility may be newly acquired or constructed, under construction, inherited, or a property upon which a full cost segregation study has never been performed.
Applicable facilities include apartment buildings, breweries, car dealerships, banks, distilleries, grocery stores, health care facilities, hotels and motels, laboratories and research facilities, and manufacturing facilities.

The list also includes office buildings, resorts, restaurants, retail malls, warehouses and wineries. In essence, any depreciable real property used in a taxpayer’s business would be suitable for a study.

How much can a cost segregation study save?

Typically, the present value of a taxpayer’s cash flows is increased by about 20 cents for each dollar reclassified out of a 39-year property. In a typical cost segregation study, between 15 and 45 percent of a building’s costs can be reclassified to shorter life assets.

The percentage depends on the type of facility and on such things as special use or process equipment, interior finishing and land improvements. For newly constructed property, the bonus depreciation allowance allows the deduction of up to 50 percent of qualifying shorter life asset costs, which accelerates the tax savings extensively.

Who would perform a cost segregation study?

The IRS requires that cost segregation studies be engineering-based. The IRS Cost Segregation Audit Techniques Guide states, ‘Preparation of cost segregation studies requires knowledge of both the construction process and the tax law involving property classifications for depreciation purposes.

‘In general, a study by construction engineers is more reliable than one conducted by someone with no engineering or construction background. Experience in cost estimating and allocation, as well as knowledge of the applicable tax law, are other important criteria.’

How would a taxpayer choose a firm to perform a cost segregation study?
A taxpayer needing a cost segregation study should use a firm that has the qualified personnel and expertise in place to perform an engineering-based study.

Generally, such a firm would have experience with this kind of work and could assist you through the process and answer any questions that might come up along the way.

A combination of registered Professional Engineers and tax-qualified CPAs would be appropriate for the work. The firm, in general, would provide a potential client with a fixed fee proposal for the cost segregation work. ●

Insights Accounting is brought to you by Cendrowski Corporate Advisors LLC

What you need to know about valuation standards and their impact

Valuation of a business or an interest in a business may be done for many purposes. What many businesses don’t understand, however, is that the applicable standard of value required in the specific situation has a direct impact on the final result.

Smart Business spoke with John T. Alfonsi, Managing Director at Cendrowski Corporate Advisors LLC, about the impact the purpose of the valuation has on the result.

What are some reasons a business valuation would be called for?

A business or an interest in a business may need to be valued for a sale of the business or interest, gift tax purposes, estate tax purposes, shareholder or partner buy-out/redemption, divorce, litigation purposes, or financial reporting purposes, among others. The same interest in the business may have a different value depending on the purpose of the valuation.

How does the purpose of the valuation affect the bottom line value?

The applicable standard of value dictates what the value may be. The standard of value answers the question ‘Value to whom?’ which has an effect in determining the value of the asset. There are many standards of value, but some of the more common are fair market value, fair value and investment value.

What are the standards?

Fair market value is probably the most common standard and the one people hear most often. It is the applicable standard for all federal tax purposes, whether it is income tax, gift tax or estate tax.

Fair market value is the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, and both parties have reasonable knowledge of relevant facts.

Court decisions frequently state in addition that the hypothetical buyer and seller are assumed to be able, as well as willing, to trade and are informed about the property and the market for such property. It is not the value to a specific person or buyer, but is generally thought of as the value to a hypothetical financial buyer.

Fair value has a couple of meanings. For financial reporting purposes, fair value means the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

It is similar to fair market value but with some subtle differences, for instance it’s meaning for state law purposes.

Fair value in state law shareholder dispute matters is generally defined as the value of the corporation’s shares determined immediately before the effectuation of the corporate action to which the shareholder objects using customary and current valuation concepts and techniques generally employed for similar businesses in the context of the transaction requiring appraisal without discounting for lack of marketability or minority.

The valuation analyst needs to be familiar with the applicable standard for the state to which the matter relates, as each state may be different. Investment value is the value to a specific person.

It is most commonly used in a sale or merger transaction as it will capture the synergies of the business with the specific buyer/acquirer.

How do these standards of value affect a 20 percent interest in a closely held business?

Where fair market value is the applicable standard, the value would be the price at which a hypothetical buyer would pay for that 20 percent interest. It may reflect any applicable discounts in that determination, such as a discount for lack of control and a discount for lack of marketability.

In a state law fair value context, the value would be 20 percent of the value of the entire business without regard to any discounts for lack of control and lack of marketability. It generally produces a value, then, which is greater than that determined under a fair market value standard.

Investment value would take into consideration synergies or value with respect to the specific buyer.

It is most commonly applied in valuing the entire business rather than an interest in the business. Investment value would generally produce a value greater than that determined under a fair market value if the buyer is a synergistic buyer rather than a financial buyer. ●

Insights Accounting is brought to you by Cendrowski Corporate Advisors LLC

What small businesses can do to prevent and detect occupational fraud

All things change, yet all things remain the same. The Association of Certified Fraud Examiners (ACFE) 2014 Report to the Nations on Occupational Fraud and Abuse (“ACFE Report”) is consistent with the organization’s prior studies, as to which entities are most likely to be victimized by fraud and measures that can be taken to effectively deter and detect fraud.

Businesses continue to be plagued with “occupational fraud,” the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets.

“Occupational fraud can be classified into three broad categories: asset misappropriations, corruption and financial statement fraud,” according to Natasha Perssico, forensic accountant, and James Schultz, Principal, at Cendrowski Corporate Advisors LLC.

Smart Business spoke with Perssico and Schultz regarding the issues of fraud and steps that small businesses can take to reduce fraud.

How common is the occurrence of fraud in small businesses, and what impact can it have?

Small businesses having fewer than 100 employees are more frequently victimized by instances of occupational fraud, accounting for nearly 30 percent of fraud cases reported. The risk to small business as targets of fraud is compounded by the fact that many small business owners think they cannot afford to invest in fraud prevention and detection policies and procedures. In actuality, small businesses cannot afford to not implement fraud prevention and detection procedures. However, median losses for small businesses and large entities are quite close in dollar amount — $154,000 and $160,000 respectively. While a larger organization might be able to absorb losses and recover from a financial blow of this magnitude, a smaller business might not be able to recover.

What steps can be taken by small businesses to prevent fraud?

Small businesses owners will be relieved to know that there are many simple, effective and affordable practices that could be implemented by small business. Here are some key steps for owners to employ to minimize acts of fraud:

  1. Segregation of Duties. Many small businesses rely on one person to open mail, process payments, make bank deposits, pay invoices, handle petty cash and reconcile bank statements. Such unchecked access creates an opportunity for fraud and misappropriation of assets. Segregating accounting responsibilities so that no single individual controls all of the financial activity and reporting of that financial activity reduces the risk of fraud.
  2. Insist on receiving and reviewing bank statements first. You should have the original or a duplicate bank statement sent to your home address or a secure P.O. Box directly from the bank. Make it a regular habit to review bank statements for missing checks, checks that are out of order, checks written to unfamiliar suppliers or other unknown persons and checks made out to a third party but endorsed by someone in your company. Informing your employees that you review the bank statements independently of accounting personnel will also serve as a fraud deterrent.
  3. Review accounts receivables, cash receipts, and uncollectible accounts. Understanding trends and investigating changes in accounts receivables and cash receipts is a useful practice. Unexplained declines in cash receipts and increases in uncollectible accounts write offs could be a flag that misappropriation of cash is occurring before bank deposits. Sending customers account statements is a good procedure that can possibly reveal any discrepancies as customers will complain if the amounts said to be owed by them are erroneously overstated. Write-offs of uncollectible accounts should also require approvals.
  4. Educate employees about what behaviors are unacceptable and how to report suspicions of fraud. Employee tips play an important role in fraud detection. Employees should be informed that fraud is unacceptable, how fraud can negatively impact the organization, and how it can negatively impact the employees personally.

What are some positive results of implementing a fraud prevention program, and who can help in creating a good program?

For small businesses even simple procedures can make a large impact on the company’s image and financial health. Organizations with strong and frequently communicated fraud deterrence policies are better situated for early fraud detection and the mitigation of large losses due to long running frauds. Further, holding other operational issues aside, organizations with strong anti-fraud programs also benefit from a less risky image leading to greater shareholder, creditor, and employee confidence in the organization.

Organizations unfamiliar with fraud prevention and fraud risk assessment programs should rely upon qualified fraud experts in conducting and implementing these important processes.

Insights Accounting is brought to you by Cendrowski Corporate Advisors.

Navigating the murky waters in a new era of electronic discovery

As technology has advanced, courts have struggled to apply federal statutes such as the Electronic Communications Privacy Act of 1986 (ECPA) in discovery. Issues regarding retrieval of electronically stored information by third parties have been ripe for litigation.

“The treatment of cloud computing-related issues in court has not been entirely clear, and case law has exemplified the fact that courts have been forced to enter unchartered territory with these types of issues,” says James P. Martin, managing director at Cendrowski Corporate Advisors LLC.

Smart Business spoke with Martin regarding the issues that can arise when attempting to obtain information in the new era of electronic discovery.

What is cloud computing?

Cloud computing describes an IT model in which computing resources can be obtained and utilized on an as-needed basis.

The end user is provided a turnkey solution that is supported and maintained by the service provider at a remote location where data is stored. ‘The cloud’ is a term referring to the pool of resources hosted on the Internet.

What are some common cloud data sources that should be considered in litigation?

People and businesses are putting more content in the cloud continuously, and a lot of that data could be of interest to adverse parties in litigation.

Cloud computing applications include hosted email products, such as Gmail or Hotmail, picture hosting services, text message services, hosted document processing, as well as social media services such as Facebook and Twitter.

How does this affect electronic discovery?

Moving to a cloud computing solution does not remove an organization’s document retention requirements, and many cloud solutions tout their ability to help organizations meet statutory requirements. If a cloud vendor performs services to the public, access to data is subject to Stored Communication Act (SCA) restrictions.

What is the SCA?

Data hosted by a third-party service provider may be covered by the SCA (18 U.S.C. §§ 2701-2712). This act was included as Title II of the ECPA.

The SCA states that ‘a person or entity providing an electronic communication service to the public shall not knowingly divulge to any person or entity the contents of a communication while in electronic storage by that service.’

The SCA was primarily written to protect the end user of computing services from government surveillance. In civil litigation, some courts concluded that contents of communications cannot be disclosed to litigants even when presented with a civil subpoena.

When the ECPA, which governs the interception and monitoring of electronic communications, was passed, cellular telephones and other electronic media for storing information did not exist.

However, 28 years later, it remains a central legislation restricting the release of electronic communications held by a third-party. As technology has frequently outpaced legislation pertaining to discovery procedures, it comes as little surprise that courts struggled with issues about retrieval of electronic communications in litigation.

How can a litigant obtain information subject to the SCA?

The SCA defines three categories of information; each category has different requirements to obtain the information.

In litigation, the parties will tend to need access to ‘contents,’ such as email conversations and documents, which has the highest threshold. Contents generally require a subpoena with notice, a court order with notice or search warrant.

One wrinkle is that the SCA defines a ‘court of competent jurisdiction’ only as any district court of the U.S. and the Court of Appeals.

How are courts dealing with third party information?

According to the ECPA, one allowable avenue for production is to obtain the permission of the entity controlling the account to produce the data; however, the identity of that entity is not always clear in complex litigation with multiple parties involved. ●

Insights Accounting is brought to you by Cendrowski Corporate Advisors LLC

How forensic accounting can help snuff out fraud and mismanagement

With increased regulatory demands and constant threats of fraud and misconduct, businesses have to watch their backs, especially when it comes to finances.

In many cases, having a traditional accountant is not enough. You may need instead someone who has not only accounting skills, but investigative and analytical skills as well. In other words, you need a forensic accountant.

“Forensic accounting enables business owners to get control over possible financial fraud and mismanagement and, more importantly, to deter it before it occurs,” says James P. Martin, CMA, CIA, CFE, managing director at Cendrowski Corporate Advisors LLC.

Martin says forensic accountants can help companies design effective antifraud controls and mitigate the risks of future lawsuits. They also might be used to quantify economic damages in instances where value and/or profits might be lost, or in cases of business valuations to uncover reported income or expenses.

Smart Business spoke with Martin to learn more about the role of forensic accounting.

How does a forensic accounting engagement differ from an audit?

First, forensic accounting engagements are nonrecurring and are only conducted at the request of a firm’s management.

Audits, conversely, are recurring activities.  Forensic accounting engagements are targeted assessments of specific areas of a business; they are not general assessments of the business as a whole or its financial statements.

The methodology employed in an audit is also quite different from that used in forensic accounting engagements. Audits are conducted primarily by examining financial data, whereas forensic accounting analyses are conducted by examining a wide variety of documents and interviews.

Lastly, the goals of forensic accounting engagements are yet again very different from audits. The goal of the latter is to detect the presence of material misstatements, irrespective of their cause.  Audit activities are in no way designed to help an organization deter fraud, though they may detect such activity.

Since many frauds begin on a small scale, they may go undetected by auditors if the size of the fraud is below the auditor’s threshold for materiality. In addition, even if the magnitude of a fraud is greater than the auditor’s threshold for materiality, a fraud may remain undetected by the auditor if it is well-concealed.

Forensic accounting engagements can be specifically tailored to deter fraud and potentially prevent it.

Can forensic accounting techniques be applied proactively?

Forensic accounting techniques can be used on a proactive basis in many instances, including the deterrence of fraud. More specifically, forensic accountants can proactively analyze an organization’s internal control process to determine areas of weakness and help the organization remediate these issues.

How can organizations use forensic accountants to help deter fraud?

Fraud deterrence focuses on removing one or more of the three causal factors of fraud: motive, opportunity and rationalization.

Only when each of these factors is present can a fraud occur. Motive and rationalization are generally dependent on personal situations over which the organization may have little control. This is why the opportunity for fraud is often the prime target of fraud deterrence engagements, as this factor can be controlled by an organization.

How can forensic accounting techniques be used in cases of business valuation?

Valuation professionals who are trained in forensic accounting may have significant experience in data mining and analysis, affording them the ability to supplement typical valuation techniques with information uncovered as a result of forensic accounting activities.

This additional information could result in a markedly different valuation from that which might have been calculated without the use of forensic accounting techniques, as valuations are extremely sensitive to underlying assumptions. ●

Insights Accounting is brought to you by Cendrowski Corporate Advisors LLC

Learning what your organization is really worth can bring dividends

The value of a business is commonly a large portion of its owner’s net worth.

Understanding what the business is really worth, or could be worth, allows an owner to make important decisions regarding key issues like retirement, estate planning and choosing a business successor.

A frequent question owners ask is, “What is my business worth?” The answer is not necessarily what the assets would sell for — a common misunderstanding of owners.

Smart Business spoke with James F. Schultz, principal at Cendrowski Corporate Advisors LLC, about how the sale value of a business is properly determined.

How is the value of a business determined?

The first step is to hire an independent valuator to determine the realistic sales price of the business.

This important step should be done by a professional experienced in merger and acquisition processes and in valuation analyses. The valuator will look at the business and use the standard valuation approaches of asset, income and market to estimate the enterprise value of the business.

For most operating businesses, the income and/or market approach will have the most influence in estimating the sale value of the business. Research is needed into the industry of the business to find trends and key economic factors driving profitability.

Next, a look at sales of comparable businesses in the industry can provide various multipliers of income factors that can be applied to the business. If comparable sales are not available, estimating proper investment returns on income based on risk/reward analysis will estimate value.

When applying the income approach, it may be necessary to identify synergies/cost savings created from the sale. This will enable the valuator to establish investment value (to an acquirer) rather than fair market value (to a hypothetical purchaser).

In cases where the return on investment is low and/or little labor is involved, the asset method may be more applicable.

What happens after the enterprise value is estimated?

The next step is to estimate what the purchaser will actually receive from the seller.

Most sale transactions today are structured as asset sales rather than stock sales. In an asset sale transaction, specifically identified assets and liabilities of the selling company will be transferred to the purchaser. The purchaser will require all the fixed assets necessary to run the business, which can range from computer systems to manufacturing machinery.

In addition to the fixed assets, the purchaser acquires various intangible assets and rights relative to trade names, patents, goodwill, occupancy/lease rights, client lists and vendor lists, to name a few. The more difficult item to quantify is the level of working capital that the purchaser will require as part of the sale transaction.

The purchaser is looking to acquire an operating business and the necessary liquidity to allow the business to continue to operate in a smooth fashion without requiring additional equity amounts.

The items typically included in working capital are accounts receivable, inventory and accounts payable.

The net value of those amounts need to provide a liquid cushion to continue business operations. The sale negotiations will normally determine the appropriate level of liquidity, and an adjustment of the purchase price may be required if the level is not met or if there is an excess when the sale closes.

In most cases, the purchaser will not assume liabilities other than trade payables.

After estimating the purchaser’s requirements, what are the final steps?

The final step is to analyze the existing balance sheet of the company for items that will not be transferred to the purchaser.

This typically consists of cash, investments and other non-operating assets on the asset side, and all liabilities excluding trade accounts payable on the liability side. The net value from the combination of the aforesaid items is then added to/subtracted from the enterprise value. The result of that computation is the estimated net sale proceeds of the business.

In order to determine what the owner will be able to put in the bank, an estimate of the income taxes related to the sale transaction should be calculated. That amount is subtracted from the estimated sale proceeds to determine the after-tax cash available to the owner. ●

Insights Accounting is brought to you by Cendrowski Corporate Advisors LLC

How to manage risk and counter crises with a corporate response plan

The goal of any incident response is to minimize the impact of a negative event on an organization’s objectives. This involves responding to an incident as quickly and efficiently as possible, making good decisions to limit further damage and repair any damage that has been done. In order to accomplish this, an organization should have a corporate response plan (CRP) in place that is ready to go at a moment’s notice.

A CRP typically includes an oversight committee that will design the CRP and oversee the work of the corporate response teams.

Smart Business spoke with James Martin, managing director at Cendrowski Corporate Advisors LLC, about the finer points of a CRP.

What sort of events should be addressed with a CRP? 

A CRP is a natural extension of an organization’s risk management process and can be designed to address risks that are particular to an organization and its industry. Such a plan could help manage risks that have a high likelihood of occurrence and a high impact if they were to occur. An organization might have several CRPs, each designed to address specific events, for instance cybercrime, fraud, business interruption and other public relations disasters.

Why does an organization need a CRP?  

Risk management attempts to identify and mitigate risks, however, it is impossible to completely prevent risk occurrence or even to identify all risks facing an organization. This is why an organization needs to be ready with a plan. The future really is unknowable; the goal of the CRP is to make sure the organization has a mindset of preparedness and the basic tools to manage a risk occurrence when it happens.

What are the basics for setting up a CRP? 

Setting up a CRP is an extension of the risk management process. It involves deep planning around what tools will be needed for specific threat types and proactively ensuring they will be available.

When a risk actually occurs there will be no time for planning and coordination, so it needs to be done upfront. Consider who should be involved, both from a company perspective and any outside experts who would be required. Identify the information that’s essential to evaluate the extent of the threat and analyze an appropriate course of information. Also, consider procedures to ensure that data and information are adequately preserved and available for the CRP.

Who should be involved?  

A corporate response committee should tailor the CRP for the company’s situation and determine who should be involved with the operation of a response team. The team is responsible for operating the CRP when an event occurs. Of course, for IT security events the committee should include members of the technology team. The members of the committee should be senior management so they can authorize the CRP and provide team members with the authority to examine transactions and events on behalf of the committee.

What are the keys to success?  

Planning needs to be done to progress from threat identification to a desired outcome — the organization needs to determine the acceptable end resolution. This will also vary by threat type, but should consider the overall goals of:

  • Minimizing business impact.
  • Resuming normal operations.
  • Repairing any damage done. 

Consideration should always be given to the need for confidentiality. For certain threats, such as a report that fraud has occurred, the CRP should involve confidentiality during the process to ensure that the investigation can proceed appropriately and protect the rights of the parties involved.
As with any other risk management activity, the CRP should also include an evaluation process to gauge the effectiveness of the response and identify areas to improve. Also, the risk occurrence and mitigation information should be used to check if prior risk evaluations for risk impact and likelihood ratings need to be updated.

Insights Accounting is brought to you by Cendrowski Corporate Advisors LLC

How forensic accounting can snuff out fraud and mismanagement

With increased regulatory demands and constant threats of fraud and misconduct, businesses have to watch their backs, especially when it comes to finances. In many cases, having a traditional accountant is not enough. Instead, you may need someone who has not only accounting skills, but investigative and analytical skills as well. In other words, you need a forensic accountant. 

“Forensic accounting enables business owners to get control over possible financial fraud and mismanagement and, more importantly, to deter it before it occurs,” says James P. Martin, CMA, CIA, CFE, managing director at Cendrowski Corporate Advisors LLCHe says forensic accountants can help companies design effective anti-fraud controls and mitigate the risks of future lawsuits. They also might be used to quantify economic damages in instances where value and/or profits might be lost, or in cases of business valuations to uncover reported income or expenses. 

Smart Business spoke with Martin to learn more about forensic accounting. 

How does a forensic accounting engagement differ from an audit? 

First and foremost, forensic accounting engagements are nonrecurring and are only conducted at the request of a firm’s management. Audits, conversely, are recurring activities. Forensic accounting engagements are targeted assessments of specific areas of a business; they are not general assessments of the business as a whole or its financial statements. The methodology employed in an audit is also quite different from that used in forensic accounting engagements.Audits

are conducted primarily by examining financial data, whereas forensic accounting analyses are conducted by examining a wide variety of documents and interviews. Lastly, the goals of forensic accounting engagements are yet again very different from audits. The goal of the latter is to detect the presence of material misstatements, irrespective of their cause. Audit activities are in no way designed to help an organization deter fraud, though they may detect such activity. 

Since many frauds begin on a small scale, they may go undetected by auditors if the size of the fraud is below the auditor’s threshold for materiality. Moreover, even if the magnitude of a fraud is greater than the auditor’s threshold for materiality, a fraud may remain undetected by the auditor if it is well concealed. Forensic accounting engagements can be specifically tailored to deter fraud and potentially prevent it. 

Can forensic accounting techniques be applied proactively? 

Forensic accounting techniques can be used on a proactive basis in many instances, including the deterrence of fraud. More specifically, forensic accountants can proactively analyze an organization’s internal control process to determine areas of weakness and help the organization swiftly remediate these issues.  

How can organizations use forensic accountants to help deter fraud? 

Fraud deterrence focuses on removing one or more of the three causal factors of fraud: motive, opportunity and rationalization. Only when each of these factors is present can a fraud occur. Motive and rationalization are generally dependent on personal situations over which the organization may have little control. This is why the opportunity for fraud is often the prime target of fraud deterrence engagements, as this factor can be controlled by an organization. 

How can forensic accounting techniques be used in cases of business valuations? 

Valuation professionals who are trained in forensic accounting may have significant experience in data mining and analysis, affording them the ability to supplement typical valuation techniques with information uncovered as a result of forensic accounting activities. This additional information could result in a markedly different valuation from that which might have been calculated without the use of forensic accounting techniques, as valuations are extremely sensitive to underlying assumptions.
James P. Martin, CMA, CIA, CFE, is the Managing Director at Cendrowski Corporate Advisors LLC. Reach him at (866) 717-1607 or [email protected]
Insights Accounting is brought to you by Cendrowski Corporate Advisors LLC

How enterprise risk management can impact a company’s value

Business operations are subject to a number of internal and external risks, as are ownership interests in businesses. How organizations and their owners address these risks can have a significant impact on the value of businesses and interests therein.  

An enterprise risk management (ERM) process involves identifying risks relative to an organization’s objectives, assessing them for likelihood and impact, developing a response strategy and monitoring progress. A well-defined ERM process framework can protect and create value for organizations and their owners.  

Smart Business spoke with John T. Alfonsi, managing director at Cendrowski Corporate Advisors LLC, about how ERM precesses can mitigate risk and increase a company’s value. 

Where is risk addressed in a business valuation? 

The most common method of valuing a business is the ‘income approach.’ It requires a valuation analyst to project a business’s future cash flows, then calculate the present value of the sum of these cash flows by employing an appropriate discount rate. The valuation analyst must address risk in two primary areas: projected future cash flows and the discount rate. 

Effective ERM 
processes can help businesses increase value by affecting the estimates for these quantities. 

How does risk impact projected cash flow?
There exists a risk that an organization will not achieve its projected figures. As such, the process by which management projects future cash flows can impact a valuation analyst’s assessment of the business. A key risk in the process is information integrity, the quality of information generated through monitoring and data assimilation.  

Information integrity allows management to make well-informed decisions and should provide a valuation analyst with greater confidence in a business’s projections. Valuation analysts can analyze information integrity by examining historical projections and assessing elements of the internal control environment. 

A valuation analyst also should examine the variance between historical projections and a business’s actual performance. If a strong correlation exists, a valuation analyst can be highly confident in current projections, if the process employed by the organization remains constant. If not, the analyst must examine the variance between the past projections and actual performance to discern whether bias existed in past estimates and current projections. 

What about risks in the discount rate?The discount rate is the yield necessary to attract capital to a particular investment, given the risks associated with that investment. A project with relatively high risk will require a relatively high yield to compensate an investor for bearing these risks.


In determining the discount rate, there are two sources of risk that need to be quantified: systematic and unsystematic. Systematic risk is the risk one must bear for taking on a risky investment in the market. However, systematic risk is estimated by calculating the return to public equities due to availability of data.The

ERM process has little impact on systematic risks unless the business’s performance is heavily tied to market performance. Unsystematic risk is sometimes broken down into two components, industry risk and company-specific risk. Industry risk reflects the risks identified with the industry in which a business operates.Company-specific

risks encompass all other risks, including size, depth of management, geography of operations, customer and/or vendor concentration, competition and financial health. 

How can ERM processes mitigate company-specific risks and increase value? 

An ERM process should quickly gather and assimilate high-quality information for use in an organization’s decision-making process, allowing the organization to rapidly assess the impact and likelihood of risks associated with changes in its internal and external environments. Early assessment and mitigation can help preserve value and capitalize on risky events when competitors do not react as swiftly to environmental changes.
Insights Accounting is brought to you by Cendrowski Corporate Advisors LLC 

How to transition your small business to an ESOP

Having a sound exit strategy in place with respect to departing shareholders is imperative for any company. This is especially true for small businesses in which the departing shareholder is a key cog in the company’s management and day-to-day operations. A departing shareholder also faces the issue of finding a market to be adequately compensated for his shares. 

“Companies and individuals are faced with the daunting task of finding a market for the shares being sold, the fear of a targeted acquisition in which the purchaser would drastically alter the landscape of the company, and the various costs and time associated with the transaction,” says Matthew P. Breuer, J.D., an associate with Cendrowski Corporate Advisors LLC. 

Accordingly, this has caused companies and shareholders to look elsewhere from traditional buy-outs for this transition. One solution that the individuals have turned to is implementing an employee stock ownership plan (ESOP).  

Smart Business spoke with Breuer about the benefits of ESOPs and how they’re implemented. 

What makes an ESOP unique? 

An ESOP is essentially an employee benefit plan in which employees can acquire ownership of the company for which they work through a qualified retirement plan. One of its defining characteristics is that an ESOP is the only qualified plan permitted and required by law to invest primarily in the stock of the sponsoring employer.  
ESOPs also offer attractive options with regard to obtaining financing and tax planning for different types of entities. Securities acquired by an ESOP are held in a trust and the employees will be the beneficial owners of the value of the stock despite not having to invest their own money. According to a 2010 survey by the ESOP Association, there were approximately 10,000 ESOPs in place in the U.S. covering roughly 10.3 million employees, which is approximately 10 percent of the private sector workforce. 

Why have so many companies turned to these types of plans? 

ESOPs have become viable options as exit strategies for shareholders for a variety of reasons. For a departing equity holder, implementing an ESOP creates a ready market place in which the shares can be purchased, thus eliminating the need to find a willing buyer. An ESOP is also advantageous in that, among qualified employee benefit plans, an ESOP is allowed to borrow funds to finance an acquisition.

This is an attractive option to 
companies that may need capital to acquire the stock. Implementing an ESOP also allows a company to receive significant tax and financial benefits. Among the numerous benefits, the dividends paid on stock held by the ESOP are fully tax-deductible, the principal can be repaid with tax- deductible funds, and the owner can choose what portion of his or her stock to sell. 

transaction costs associated with ESOPs are also comparable to traditional buy-outs.  

How does an ESOP transaction work? 

Most often a company will elect to obtain financing through a third party, which is known as a leveraged ESOP. Stated simply, a bank will lend money to the company and the ESOP will then buy stock from the company or the shareholder(s). The company in turn will make annual tax-deductible contributions to the ESOP, which will repay the bank for the original note. Employees will then receive stock or cash when they retire or depart from the company.Under certain circumstances,

selling shareholders can defer the entire gain recognized from the sale of shares for federal income tax purposes. 

What makes a company an ideal candidate to implement an ESOP? 

ESOPs are effective exit strategies, particularly with smaller companies. They can serve as an effective method of transition by having a purchaser already lined up and selling the stock in a tax efficient manner. Smaller companies also have the ancillary benefit of motivating employees through an ESOP purchase. To correctly adopt an ESOP, you need to have a team in place that has experience with finance, legal and tax support, benefit plans, and can coordinate effectively.
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