Business Evaluation Based on Accounting Polices (Part 3)

The fundamental goal of a business evaluation regarding accounting policies is for Capital Corp Merchant Banking’s Due Diligence team to fully analyze the major financial accounts and discern their effect on the reported income / loss.  

Those results should then be compared to what the financial results would have been if the business employed certain practices; say, after the investment is made or perhaps in practice by comparable companies in the same industry group.

The first example deals with one of the most highly contested accounts reviewed during a business evaluation: inventory.  The two major inventory polices well-known to all is LIFO (last-in, first-out) and FIFO (first-in, first-out).  Alone, those two polices have their own effect to reported income - but what about inventory that has not changed, or FISH (first-in and still here)?

Inventory that is purposely over-counted or not even still in existence would overstate profit.  Pricing inventory based on historic sales will also provide an unrealizable income value.  Furthermore, keeping inventory considered “obsolete” by business managers on the financial books at full-value incorrectly drives up the balance sheet.  On the other hand, inventory that has been fully written down but not trashed could be seen as a hidden asset to an investor.

Based on the above, inventory accounting policy decisions may easily change the reported income of a business but they are not the only account to do so.  Further examples will be detailed in posts following this one.

Respectfully,

Capital Corp Merchant Banking