INFocus: Business analysis in today’s uncertain times

Date: April, 2013 uncertain stock numbers

When people learn that I am a “forensic accountant,” I am not surprised if they picture an accounting sleuth diligently searching for the proceeds of crime. However, the field in which I specialize, namely loss quantification, lends itself more to using business “smarts” than the “Sherlock Holmes” image of a detective finding the criminal.

The need for “loss quantification” arises in many types of insurance or litigation claims, particularly when an earnings loss has occurred. This need is often accompanied by the underlying question: “How much income would have been earned if the adverse event had not occurred?” And from this “what if” beginning, one quickly moves into the arena of financial and business analysis, gaining a real understanding of the business issues behind the numbers.

Accountants and business owners alike are used to seeing financial statements. And, of course, detailed accounting records, with all the “debits and credits” involved, are familiar territory for accountants. But the problem is that, in most cases, neither financial statements nor detailed accounting records provide an adequate route to business problem solving. Simply, financial statements provide insufficient information by business segment and by product/market, and detailed records contain too much information to gain a summary picture.

Financial statements may provide the 50,000 feet picture, and detailed accounting records provide a view at ground level. However, business problem solving often requires a 10,000 feet view.

For example, let’s say we are dealing with a hotel. Detailed accounting data may be helpful, but is unlikely to readily provide revenue analysis based on different customer segments. Further, financial statements may provide summarized data with regard to room revenues, but do they provide data to distinguish between occupancy trends and average room rates? From this example, it is not difficult to envision why detailed records are not useful for analyzing business trends, while consolidated results may aggregate different business sectors at a level which precludes useful further analysis.

Many years ago, I worked as a controller in a multi-division manufacturing company. One particular plant (which manufactured custom products) had incurred a significant loss during the first six months of one fiscal year, but was forecasting to earn a profit during the subsequent six months. After several hours of developing a business model based on major contracts on hand, I predicted that the plant would continue to lose money during the remainder of the year. The manner in which I made the prediction was:

  • tracking expected business revenues for products to be shipped, based on orders on hand;
  • assembling manufacturing costs based on original cost estimates at the time of quotation; and
  • adjusting the assembled manufacturing costs based on recent manufacturing performance.

Summary analysis such as this is so meaningful that it is invaluable to senior management, allowing performance to be tracked and – where necessary and possible – remedial actions to be taken on an ongoing basis.

As a forensic accountant involved in loss quantification, the range of the industries I have been exposed to over the years has been – to say the least – varied. From a global manufacturer of industrial chemicals, to family-owned small retail stores, the businesses involved may have had little in common, but the financial analysis required had many similarities. What were the individual product lines to be separately considered? Was there any seasonality to be reflected in business projections? How was pricing influenced by external factors, such as commodity prices and exchange rates? How had the business historically performed based on industry trends?

Using a high-end clothing store as an example, revenues could be analyzed between (a) menswear and womenswear, and (b) fall/winter versus spring/summer revenues. Further, impacts of (i) exchange rates, (ii) seasonal promotions, and (iii) local economic trends could all be considered. Taking these factors into account, and with due consideration of the actual events that transpired, it was not difficult to build supportable projections of “what might have been,” had the adverse event not occurred.

In loss quantification claims, it is possible to fall into a trap of focusing too heavily on year-over-year number comparison, with insufficient emphasis on business and industry analysis. The world is changing. Robotics is replacing human labour in manufacturing environments, resulting in production efficiencies for those businesses that are investing in technology. Yesterday’s market leaders are being overtaken based on changes in consumer buying patterns and continuing technological advancement. The real impact of these changes cannot be fully understood just from looking at the numbers.

Most of the time the numbers only tell part of the story; it is the underlying business and industry trends, which really “do the talking.” And just as these underlying trends can “talk” to loss quantification accountants, they can – and should – be talking to every business owner. Do you know where your business is going?

Connect with the Author

Daniel M. Edwards, MA, CPA, CA • IFA, CBV, CFE, CFF, Daniel M. Edwards Professional Corporation – Partner, Valuations | Forensics | Litigation

Daniel Edwards is a partner in the Valuations | Forensics | Litigation Group at Crowe Soberman LLP where he has deep experience in quantification of losses or payments in insurance or litigation claims. You may reach Daniel by phoning 416.963.7221 or emailing daniel.edwards@crowesoberman.com.

Specific professional advice should be obtained prior to the implementation of any suggestion contained in this article.

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Originally published in the Spring 2013 issue of Comments.

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