06
Thu, Aug
20 New Articles

Forensic Accounting

Forensics

by Antony Fanshawe

Forensic accounting

I have been asked to write about Forensic Accounting, which is a dull subject which I, mysteriously, find quite exciting. I think it’s the word forensic. Having always wanted to be a detective, the idea of finding clues, chasing them down and then fitting a sustainable narrative to them is, to me, fascinating. Accounting is a language for communicating financial information about business, but business activities are nuanced, and the numbers alone cannot fully reveal the motivations and outcomes of transactions. This is where experience is invaluable- in understanding the business and the context of the events and interpreting the accounts accordingly. Experience helps filter the important issues from the flotsam and informs the reporting of findings and opinions concisely for the benefit of the Court.

What I do is story-telling, but non-fiction; history not romance!

I have come to expert work by a roundabout route. I am a chartered accountant, who qualified with Price Waterhouse and then went into their insolvency department in 1981 after a spell in Egypt. I left PW in 1990 setting up my own corporate finance and recovery practice, Fanshawe Lofts, which traded very successfully for 18 years until 2008 when we sold it to Begbies Traynor. I was a partner with BTG until the end of 2012. In early 2013 I set up FPN Ltd with my business partner, and in 2018 I decided not to renew my Insolvency Licence, turning my hand to Corporate Finance, strategic advisory and expert work.

In 2002 I was awarded an MBA by the University of Bath and for 12 years I was a member of R3 Council, and instrumental in establishing the Thames Valley chapter of R3

I have taken on expert assignments since the turn of the (21st) century, these have varied from business valuations for divorce, to wrongful and, in one case, fraudulent, trading allegations, by way of preferences, misfeasance, and insolvency practitioners’ conduct and fees.

I have always seen my expert work as being an adjunct to my main practice, and being informed by my advisory work, rather than being the main source of my income.

In addition to appearing in court (of which more below), I have assisted with mediations and negotiated settlements.

I work on both sides of the fence, but increasingly I am instructed by the defence.

Cross Examination

Let’s start with the tricky bit, the elephant in the room, the acid test, which can reduce the most confident experts to gibbering wrecks, and which most experts hope will never happen to them- Cross Examination.

I work on the assumption that every case could end up in court, and that means cross examination. And so the choice of an expert should, in my view, be made with that outcome in mind.

Being cross-examined is undoubtedly nerve-wracking, and can be difficult if the expert is mainly desk bound and not used to robust social interactions. I have a strong minded wife and children and I am a former IP. So, I am used to being criticised. This experience stands me in good stead whether I am cold calling to sell a business or giving evidence under cross-examination.

The first thing I learnt about expert work is to turn to the bench and address my comments to the judge. I never forget that my job is to assist the Court in coming to its judgement and not to assist Counsel facing me.

This is really helpful in overcoming the initial butterflies. I find that by being helpful to the court the court will often reciprocate and be helpful to me.

There are other tricks. Imagine that Counsel (theirs not yours) is naked, for example. But this can be too much to bear…..

I also remind myself that I have a considerable depth of expertise and experience, which is rare if not unique, and I am comfortable with it. And opposing Counsel has his/hers. Theirs is law and mine is real and commercial life, insolvency practice and accountancy. If you think about these categories of knowledge as Venn diagram sets, our sets overlap. I know something about the law, and barristers know something about real life and accountancy for example. But I have found that when it comes to accountancy and commercial practice there can be weaknesses in the attack.

It is crucial to know your stuff. Not just technical knowledge but also the nitty gritty of your assignment and the commercial context of the business. It is also important to express yourself clearly, concisely and in everyday language, avoiding needless technical terms where possible. Above all you need to be able to think on your feet and respond quickly.

The argument concerned the profitability of the (construction) company during a period of alleged wrongful trading, much of which turned on the margins achieved. I was, out of the blue, shown an earlier year’s results from the comparable period, which showed a gross margin of 17%, which the opposing Counsel seemed to think was a poor result. I replied, without any appreciable delay, that if that margin had been achieved in the period of wrongful trading then the company would have been quite profitable.

There was a collapse of (a rather) stout party (not one to imagine naked), and the Court found in favour of my clients.

I am not always as lucky as that. Benjamin Franklin said “Diligence is the mother of good luck”. I like to think that this is right, but it might not be because Donald Trump thinks “Everything in life is luck”. You decide.

Assumptions

Accounting is as I have said a language for business. And like any language it is governed by rules. It may seem strange to say but it’s not the numbers that tell the story but the assumptions and the accounting standards that lie behind them. With different interpretations, losses can become profits and insolvent balance sheets can look quite handsome.

The most common argument is the treatment as assets of expenditure which may or may not yield a return to the business in the future eg R&D, goodwill on acquisition, work in progress or stock and so on. The effect is to avoid any hit to profit and to improve or at least sustain the balance sheet. You may have noticed that this habit has slipped into the political vocabulary in the last few years. Listen to politicians talk about “investment” rather than expenditure; so much more attractive, but at the end of the day they are still spending your cash.

It does matter where the debit for the payment goes. In one of my cases the pleadings had treated payments to another company in the same group as benefitting the receiving party. But the other side of the accounting entry had gone to the intercompany account and they had been repaid- hence there was no permanent benefit to the recipient. However other payments had been incurred on behalf of the other companies in the group. A large part of my job was to help sort out the pleadings and replace them with a new argument with in depth evidential support from the accounting records.

When looking at the commercial reality facing a company an analysis of the cash position and likely projection can be much more revealing than the conventional accounts. Ultimately the success or failure of a business turns on its ability to generate or raise cash (whether debt or equity). Profit, at the end of the day is a proxy for cash generation and sometimes not a very good one!

It is a truism that the one thing you know about financial forecasts is that they will be wrong. They are though useful as an indicator of what could happen in the business. And at the very least they should make management think about their business, understand their cost structures and be realistic about what sales and margins they should achieve. Forecasts are always under-pinned by assumptions. Once the assumptions are understood- not always an easy task as accountants are often very poor at stating assumptions- it is a question of understanding whether the assumptions make sense in the context of the historic performance of the business and its current performance (in winning contracts for example). It is equally important that the forecasts should be well-constructed and reflect the stated assumptions (eg do they really show debtors being collected on 60 days?). If not they may have to be re-done.

Early engagement

Like many of my fellow experts, I am of a certain age, and have seen a lot in my professional life. And I like to share it. I know that budgets are tight in litigation, but can I respectfully suggest that a meeting with the expert at an early stage in the process can be very worthwhile? In the case of my specialism it can bring a commercial and “best practice” viewpoint to inform the approach taken to the conduct of the claim which can avoid or at least mitigate the need to change course, expensively, at a later point in the process.

To issue, or not to issue, is a very big financial decision for the client, and so it’s critical that the advisers do their best to ensure that the target is worthwhile and the strategy as well informed as it can be. Lawyers do very good law. Old IP’s do very good commercial. They are two different things. But at the end of the day clients tend to be interested in the commercial and rarely the law.

Remember, sometimes the best advice is to do nothing.

The Approach

Information gathering comes first, as in any professional exercise. This means reading and internalising the brief and the supporting papers, speaking to the principals, if possible, researching the company and its business by searches both of the company and its directors and by general internet searches around the subject. Understanding the business and how it was/is conducted and its commercial and regulatory environment can help build an idea of the context in which the company operated and how it operated. It really helps me to be able to relate the instruction to businesses that I have been involved in (or deconstructed in my role as an insolvency practitioner) in the past, and to recollect (if I can) any tricks of the trade or pitfalls, and if possible to think myself into the mind-set of the directors or the insolvency practitioner.

At this stage the picture I have is, necessarily, broad brush. It needs focus, and that means financial analysis. It’s amazing what emerges once one does some simple ratios and look at the trends over a number of years.

Gross margins are always very revealing. Are they too low/high for this type of business. If so, why? I would expect to be told that there is a solid commercial reason but it could be something else- the costs accounted for in arriving at the gross margin (is labour treated as direct or overhead?) or something as simple as the calculation of the stock value. If stock is what we call a plug figure (ie a guess) then the gross margin will be inevitably be wrong taken because stock movement is an important number in the calculation. Equally stock write offs will affect gross margin as will the basis of valuation of stock or work-in-progress, or any changes in the method of accounting year on year. All of this could affect underlying profitability, and may need to be explored, explained and interpreted in the context of the questions asked.

It can be a useful technique in getting to the heart of the matter to posit a counterfactual. So, one can say, this is what happened (say, the behaviour complained of), and this is what the outcome was. What would the outcome have been if something else had happened (which is not being complained of)? The argument goes, if the outcome was similar why is behaviour A wrong and B acceptable? This is one of the most interesting parts of the job as it requires a degree of creativity and very clear exposition and application of the assumptions adopted.

Making Mistakes

We can all be geniuses when we are comfortable and unchallenged. It’s relatively easy to produce attractive and superficially persuasive first reports. But that feeling of satisfaction rarely survives the first experts’ meeting when the report will be picked over thoroughly, conclusions will be challenged and any errors will be picked up and magnified. Mistakes can reduce the expert’s credibility when it comes to cross examination, and the confidence of his professional team. I know only too well how easy it is inadvertently to overlook transcription errors or Excel formulas that pick up the wrong cells. When found they need to be corrected without delay.

Check and double check, and then ideally get someone else to check it again. It becomes almost impossible to read one’s own work with any objectivity after a while, and fresh pair of eyes is invaluable.

I have recently seen a report where the expert has had to replace four (yes four) appendices because they were all wrong- by which I mean that they did not match their description, and consequently undermined the argument he was trying to make and by implication the integrity of the rest of his report.

This was a report produced by a top ten firm. The work had been delegated by the (partner) expert, and clearly not fully checked before it was released. I was impressed by the partner’s grasp, but less so by his assistants’ and the firm’s quality assurance.

I do all the work myself, and while that can be limiting, I do know what work has been done, I am very familiar with the facts and arguments, and I take full responsibility for my output.

But we are human and there but for the Grace of God go all of us. These things can hole an argument below the waterline, and change the balance in the negotiations.

Coming to Conclusions

When it comes to giving opinions on the evidence, I find myself from time to time thinking the same as Sherlock Holmes (fictionally) did when he repeatedly said to Watson, “When you have eliminated the impossible, whatever remains, however improbable, must be the truth. We know that he did not come through the door, the window, or the chimney. We also know that he could not have been concealed in the room, as there is no concealment possible. When, then, did he come?" (Sign of Four). What this reveals is a willingness to think the improbable and to think it in 4 dimensions. Sherlock does not ask where he came in, he asks when did he come- so it is not a question about a place in space but a place in time.

And that requires thought and relevant knowledge. And that’s the hardest part, and the bit you can’t see, and, which, at the end of the day, is what gets results.

Thank you

Antony Fanshawe October 2018

Antony can be contacted on 07979 103275 or at antony@fpn.uk.com.

www.fpn.uk.com

 

by Antony Fanshawe

Forensic accounting

I have been asked to write about Forensic Accounting, which is a dull subject which I, mysteriously, find quite exciting. I think it’s the word forensic. Having always wanted to be a detective, the idea of finding clues, chasing them down and then fitting a sustainable narrative to them is, to me, fascinating. Accounting is a language for communicating financial information about business, but business activities are nuanced, and the numbers alone cannot fully reveal the motivations and outcomes of transactions. This is where experience is invaluable- in understanding the business and the context of the events and interpreting the accounts accordingly. Experience helps filter the important issues from the flotsam and informs the reporting of findings and opinions concisely for the benefit of the Court.

What I do is story-telling, but non-fiction; history not romance!

I have come to expert work by a roundabout route. I am a chartered accountant, who qualified with Price Waterhouse and then went into their insolvency department in 1981 after a spell in Egypt. I left PW in 1990 setting up my own corporate finance and recovery practice, Fanshawe Lofts, which traded very successfully for 18 years until 2008 when we sold it to Begbies Traynor. I was a partner with BTG until the end of 2012. In early 2013 I set up FPN Ltd with my business partner, and in 2018 I decided not to renew my Insolvency Licence, turning my hand to Corporate Finance, strategic advisory and expert work.

In 2002 I was awarded an MBA by the University of Bath and for 12 years I was a member of R3 Council, and instrumental in establishing the Thames Valley chapter of R3

I have taken on expert assignments since the turn of the (21st) century, these have varied from business valuations for divorce, to wrongful and, in one case, fraudulent, trading allegations, by way of preferences, misfeasance, and insolvency practitioners’ conduct and fees.

I have always seen my expert work as being an adjunct to my main practice, and being informed by my advisory work, rather than being the main source of my income.

In addition to appearing in court (of which more below), I have assisted with mediations and negotiated settlements.

I work on both sides of the fence, but increasingly I am instructed by the defence.

Cross Examination

Let’s start with the tricky bit, the elephant in the room, the acid test, which can reduce the most confident experts to gibbering wrecks, and which most experts hope will never happen to them- Cross Examination.

I work on the assumption that every case could end up in court, and that means cross examination. And so the choice of an expert should, in my view, be made with that outcome in mind.

Being cross-examined is undoubtedly nerve-wracking, and can be difficult if the expert is mainly desk bound and not used to robust social interactions. I have a strong minded wife and children and I am a former IP. So, I am used to being criticised. This experience stands me in good stead whether I am cold calling to sell a business or giving evidence under cross-examination.

The first thing I learnt about expert work is to turn to the bench and address my comments to the judge. I never forget that my job is to assist the Court in coming to its judgement and not to assist Counsel facing me.

This is really helpful in overcoming the initial butterflies. I find that by being helpful to the court the court will often reciprocate and be helpful to me.

There are other tricks. Imagine that Counsel (theirs not yours) is naked, for example. But this can be too much to bear…..

I also remind myself that I have a considerable depth of expertise and experience, which is rare if not unique, and I am comfortable with it. And opposing Counsel has his/hers. Theirs is law and mine is real and commercial life, insolvency practice and accountancy. If you think about these categories of knowledge as Venn diagram sets, our sets overlap. I know something about the law, and barristers know something about real life and accountancy for example. But I have found that when it comes to accountancy and commercial practice there can be weaknesses in the attack.

It is crucial to know your stuff. Not just technical knowledge but also the nitty gritty of your assignment and the commercial context of the business. It is also important to express yourself clearly, concisely and in everyday language, avoiding needless technical terms where possible. Above all you need to be able to think on your feet and respond quickly.

The argument concerned the profitability of the (construction) company during a period of alleged wrongful trading, much of which turned on the margins achieved. I was, out of the blue, shown an earlier year’s results from the comparable period, which showed a gross margin of 17%, which the opposing Counsel seemed to think was a poor result. I replied, without any appreciable delay, that if that margin had been achieved in the period of wrongful trading then the company would have been quite profitable.

There was a collapse of (a rather) stout party (not one to imagine naked), and the Court found in favour of my clients.

I am not always as lucky as that. Benjamin Franklin said “Diligence is the mother of good luck”. I like to think that this is right, but it might not be because Donald Trump thinks “Everything in life is luck”. You decide.

Assumptions

Accounting is as I have said a language for business. And like any language it is governed by rules. It may seem strange to say but it’s not the numbers that tell the story but the assumptions and the accounting standards that lie behind them. With different interpretations, losses can become profits and insolvent balance sheets can look quite handsome.

The most common argument is the treatment as assets of expenditure which may or may not yield a return to the business in the future eg R&D, goodwill on acquisition, work in progress or stock and so on. The effect is to avoid any hit to profit and to improve or at least sustain the balance sheet. You may have noticed that this habit has slipped into the political vocabulary in the last few years. Listen to politicians talk about “investment” rather than expenditure; so much more attractive, but at the end of the day they are still spending your cash.

It does matter where the debit for the payment goes. In one of my cases the pleadings had treated payments to another company in the same group as benefitting the receiving party. But the other side of the accounting entry had gone to the intercompany account and they had been repaid- hence there was no permanent benefit to the recipient. However other payments had been incurred on behalf of the other companies in the group. A large part of my job was to help sort out the pleadings and replace them with a new argument with in depth evidential support from the accounting records.

When looking at the commercial reality facing a company an analysis of the cash position and likely projection can be much more revealing than the conventional accounts. Ultimately the success or failure of a business turns on its ability to generate or raise cash (whether debt or equity). Profit, at the end of the day is a proxy for cash generation and sometimes not a very good one!

It is a truism that the one thing you know about financial forecasts is that they will be wrong. They are though useful as an indicator of what could happen in the business. And at the very least they should make management think about their business, understand their cost structures and be realistic about what sales and margins they should achieve. Forecasts are always under-pinned by assumptions. Once the assumptions are understood- not always an easy task as accountants are often very poor at stating assumptions- it is a question of understanding whether the assumptions make sense in the context of the historic performance of the business and its current performance (in winning contracts for example). It is equally important that the forecasts should be well-constructed and reflect the stated assumptions (eg do they really show debtors being collected on 60 days?). If not they may have to be re-done.

Early engagement

Like many of my fellow experts, I am of a certain age, and have seen a lot in my professional life. And I like to share it. I know that budgets are tight in litigation, but can I respectfully suggest that a meeting with the expert at an early stage in the process can be very worthwhile? In the case of my specialism it can bring a commercial and “best practice” viewpoint to inform the approach taken to the conduct of the claim which can avoid or at least mitigate the need to change course, expensively, at a later point in the process.

To issue, or not to issue, is a very big financial decision for the client, and so it’s critical that the advisers do their best to ensure that the target is worthwhile and the strategy as well informed as it can be. Lawyers do very good law. Old IP’s do very good commercial. They are two different things. But at the end of the day clients tend to be interested in the commercial and rarely the law.

Remember, sometimes the best advice is to do nothing.

The Approach

Information gathering comes first, as in any professional exercise. This means reading and internalising the brief and the supporting papers, speaking to the principals, if possible, researching the company and its business by searches both of the company and its directors and by general internet searches around the subject. Understanding the business and how it was/is conducted and its commercial and regulatory environment can help build an idea of the context in which the company operated and how it operated. It really helps me to be able to relate the instruction to businesses that I have been involved in (or deconstructed in my role as an insolvency practitioner) in the past, and to recollect (if I can) any tricks of the trade or pitfalls, and if possible to think myself into the mind-set of the directors or the insolvency practitioner.

At this stage the picture I have is, necessarily, broad brush. It needs focus, and that means financial analysis. It’s amazing what emerges once one does some simple ratios and look at the trends over a number of years.

Gross margins are always very revealing. Are they too low/high for this type of business. If so, why? I would expect to be told that there is a solid commercial reason but it could be something else- the costs accounted for in arriving at the gross margin (is labour treated as direct or overhead?) or something as simple as the calculation of the stock value. If stock is what we call a plug figure (ie a guess) then the gross margin will be inevitably be wrong taken because stock movement is an important number in the calculation. Equally stock write offs will affect gross margin as will the basis of valuation of stock or work-in-progress, or any changes in the method of accounting year on year. All of this could affect underlying profitability, and may need to be explored, explained and interpreted in the context of the questions asked.

It can be a useful technique in getting to the heart of the matter to posit a counterfactual. So, one can say, this is what happened (say, the behaviour complained of), and this is what the outcome was. What would the outcome have been if something else had happened (which is not being complained of)? The argument goes, if the outcome was similar why is behaviour A wrong and B acceptable? This is one of the most interesting parts of the job as it requires a degree of creativity and very clear exposition and application of the assumptions adopted.

Making Mistakes

We can all be geniuses when we are comfortable and unchallenged. It’s relatively easy to produce attractive and superficially persuasive first reports. But that feeling of satisfaction rarely survives the first experts’ meeting when the report will be picked over thoroughly, conclusions will be challenged and any errors will be picked up and magnified. Mistakes can reduce the expert’s credibility when it comes to cross examination, and the confidence of his professional team. I know only too well how easy it is inadvertently to overlook transcription errors or Excel formulas that pick up the wrong cells. When found they need to be corrected without delay.

Check and double check, and then ideally get someone else to check it again. It becomes almost impossible to read one’s own work with any objectivity after a while, and fresh pair of eyes is invaluable.

I have recently seen a report where the expert has had to replace four (yes four) appendices because they were all wrong- by which I mean that they did not match their description, and consequently undermined the argument he was trying to make and by implication the integrity of the rest of his report.

This was a report produced by a top ten firm. The work had been delegated by the (partner) expert, and clearly not fully checked before it was released. I was impressed by the partner’s grasp, but less so by his assistants’ and the firm’s quality assurance.

I do all the work myself, and while that can be limiting, I do know what work has been done, I am very familiar with the facts and arguments, and I take full responsibility for my output.

But we are human and there but for the Grace of God go all of us. These things can hole an argument below the waterline, and change the balance in the negotiations.

Coming to Conclusions

When it comes to giving opinions on the evidence, I find myself from time to time thinking the same as Sherlock Holmes (fictionally) did when he repeatedly said to Watson, “When you have eliminated the impossible, whatever remains, however improbable, must be the truth. We know that he did not come through the door, the window, or the chimney. We also know that he could not have been concealed in the room, as there is no concealment possible. When, then, did he come?" (Sign of Four). What this reveals is a willingness to think the improbable and to think it in 4 dimensions. Sherlock does not ask where he came in, he asks when did he come- so it is not a question about a place in space but a place in time.

And that requires thought and relevant knowledge. And that’s the hardest part, and the bit you can’t see, and, which, at the end of the day, is what gets results.

Thank you

Antony Fanshawe October 2018

Antony can be contacted on 07979 103275 or at This email address is being protected from spambots. You need JavaScript enabled to view it..

www.fpn.uk.com

 

Sign up via our free email subscription service to receive notifications when new information is available.