By Laura P. Ewart, CPA, valuations supervisor at CPAmerica
In virtually all matrimonial litigation cases in which one spouse is a business owner, the expert retained in the case must analyze and report on two issues.
The first issue is the value of the business owner’s interest in the company. The second is the amount of cash flow the business owner is receiving from the company.
Cash-flow analysis is necessary to determine income for the calculation of alimony and child support. We typically analyze the last three years of the business owner’s cash flow.
Our starting point for a cash-flow analysis is the salary the business owner receives from the company, as well as distributions and/or loans the owner is taking.
The next step is an analysis of the company’s general ledgers to determine what perquisites may exist that should be included in the business owner’s cash flow. Any payment of items that are for the personal benefit of the business owner or the owner’s family is considered cash flow to him.
Examples of these payments include automobile expenses, travel and entertainment, mortgage or other personal obligation payments. The key phrase to remember in this analysis is “personal benefit.”
Our firm was recently retained by the husband in a matrimonial matter. The husband owns and operates a construction business. A prenuptial agreement exists in this case and, as per the agreement, the business is an exempt asset. Therefore, a business valuation was not necessary. However, a cash-flow analysis was still required for support purposes.
The Findings
At our initial interview, the husband told us his business had plummeted over the last few years, and he was not capable of continuing to earn what he has historically.
Operating within the construction industry in today’s economy may make this a reasonable scenario. However, an analysis of the cash flow from the business revealed he continued to receive $200,000 to $300,000 per year.
As the expert, we must reconcile what the client is saying to us with what we are seeing in the records we are provided.
Analyses of the historic trends of the company are consistent with what we were told. From 2008 to 2009, gross sales dropped $12 million, and from 2009 to 2010 it dropped another $5 million. Correspondingly, net operating income fell from a profit of $100,000 in 2008 to losses of $850,000 in 2009 and $460,000 in 2010.
The question is, how is this business owner sustaining this level of cash flow given the financial situation of the company?
An examination of the detail of the revenue and expenses in all three years was conducted to confirm profits were not deflated by payments for personal items.
Our findings were that the losses were being caused by continued high insurance premiums, labor burden costs and several other fixed costs not yet decreased while revenue dropped sharply. The reconciliation was found in the trend analysis of the balance sheets.
In 2008, the company assets consisted of cash of $1.3 million and accounts receivable of $3.6 million. Also in 2008, the net equity of the company was $750,000. In 2010, the assets had fallen to $300,000 of cash and $300,000 of accounts receivable and equity to a negative $600,000.
The liquidation of these assets over the last three years had been funding both the operations of the company as well as the business owner’s cash flow. Therefore, while the business owner’s cash flow does not appear to be affected over the last three years, it will not be able to continue beyond the exhaustion of the assets. This disclosure is imperative to our report.
Each case has nuances that require the keen analytical skills of the expert. Careful planning and procedures can help assure that you have captured all the relevant data needed to issue useful reports that will help resolve the issues of your case.