Hello, my name is Richard Claywell and this is Litigation Speaks.

This week, I am discussing making a projection/forecast and having the depreciation expense exceed the capital expenditures.  However, before I get started I want to reiterate again that the example I am showing is from an actual case and this is what business valuation experts are actually doing.  I have found these errors in large and small firms.

I was provided with a business valuation report a couple of weeks ago that was prepared by a partner of an international accounting firm that also does business valuations.  The topic of depreciation expense is one of many items that do no follow and therefore are not generally accepted business valuation practices.

What is the Perpetuity?

Business valuations are based on a value estimate as of a single, specified date and usually assumes the business will operate into perpetuity.  The values indicated in a business valuation report that will continue forever are indicated as terminal values.  In the report being discussed, the partner used a capitalization of cash flows and assumed the ongoing capital expenditures would be $8,000 and the depreciation expense would be $10,000.  This relationship would apply to this business valuation into perpetuity.

Resulting Analysis is in Error

I prepared the following table to illustrate what the business valuation is saying.  The table I prepared is for only ten years but in the business valuation report, the depreciation expense and capital expenditures relationship will remain the same forever.

The depreciation expense for the next ten years will total $100,000 and the capital expenditures will total $80,000.  What the business valuation expert from the large international accounting firm is saying is that there will continue to be a depreciation expense when the assets are fully depreciated and there will never be enough capital expenditures in the future to support the future depreciation expense.

As can be seen in the table above, the capital expenditures will never be sufficient to support the depreciation expenses purported by the business valuation expert.

Comment

This is another area that is easy for the attorney to review and make a determination if either business valuation expert has made this error.   This error will have a negative impact on all calculations that are dependent on the terminal year depreciation and capital expenditures.

Why should the attorney care?

The attorney will be advised of a result that does not have a basis for reliability.

The unreliable value or damage amount may be to the detriment of your client and this may be embarrassing to explain to a client.

I provide a more thorough analysis in a report so it will withstand scrutiny.

I provide calculations imbedded in the report for most analysis instead of just stating a result.

I have earned the most difficult business valuation designations for valuations of closely held companies.

I have earned a Master’s Degree in Business Valuations and apply those skills to my everyday business valuations.

Because you as the attorney need to detect the deficiencies in business valuation (damages reports).  The better informed you are, the better the outcome of your cases…for you and your clients!

Richard Claywell has been valuing closely held companies since 1985.  He has earned two of the highest designations in the business valuation field , the Certified Business Appraiser (“CBA”) and Accredited Senior Appraiser (“ASA”),  Richard is a Certified Public Accountant, has a Master’s in Business Valuation (MBV)  and holds the ASA, CBA, ABV, ICVS, CVA, MAFF, CFD, CVGA, ICVS-A credentials.

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