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The Hunt For Hidden Cash and Unreported Income

Posted in Business Valuation, on Jun 2018, By: Mark S. Gottlieb

 

Discussing hidden cash and unreported income is always a popular topic for both commercial litigators and family law attorneys.  Currently, we are working on a number of business valuation engagements that have developed into “full blown” forensic accounting and fraud exercises.  Since these issues are currently on my mind, I thought a quick review of some of these issues and techniques would be of interest.

Hunt For Hidden Cash

Contrary to conventional thinking, forensic accountants don’t automaitclly assume that every closely-held business owner hides cash.  Arguably, some business are more susceptible than others. However, when red flags appear, further due diligence is often required.

Experts (as well as IRS investigators) typically rely on certain forensic accounting techniques to prove that cash is missing and to estimate how much income the business owner isn’t reporting. These methods include:

Bank deposits. This method involves reconstructing income. In this instance we analyze the spouse’s bank deposits, canceled checks and currency transactions, accounting for cash payments made from undeposited currency receipts, as well as nonincome sources of cash. Nonincome cash sources might be loans, gifts, inheritances or insurance proceeds.

Source and funds application. Here, the business owner’s personal sources and uses of cash are analyzed. This approach can be effective in determining where the owner’s income and other funds came from, and how they eventually were used. If the owner is spending more money than he or she is taking in, the excess represents unreported income.

Net worth. An unsubstantiated increase in a business owner’s net worth can reveal unreported income. Using telltale documents such as bank and brokerage statements, real estate records, and loan or credit card applications are often used to define this increase. We start with the amount of gain in net worth, and then subtract any reported income. This amount is further adjusted to reflect any nondeductible expenditures, such as capital asset acquisitions, and nonincome sources of funds.

Percentage markup. Net income is often estimated by applying a benchmark profit percentage to sales or some other base amount. In most cases, this method is used as a reasonableness check to corroborate the results of other approaches.

Income and outputs

Looking for hidden cash is only one part of the forensic accountant’s job. As mentioned before, it usually defines concealed sources of income. As forensic experts we employ accounting techniques to reconstruct unreported income by examining potential sources of that income. These techniques vary by engagement, company size and industry.

Access the right information

Although we as forensic accounting experts are responsible to quantify the potential hidden cash and unreported income, we rely on the legal expertise of attorneys to ensure they we obtain the right information. If discovery isn’t adequate, our efforts and conclusions may be incomplete.

For additional information on this or any other issues related to business valuation, forensic accounting or litigation support please feel free to contact our office at the above phone numbers. You can also email our office at msgcpa@msgcpa.com for immediate assistance.