Financial Forecasts and Projections in Litigation

When reviewing an expert's valuation or damages report in a litigation proceeding, a point that is often missed is the efficacy of the financial forecasts or projections used by the expert in arriving at his or her opinion. These forecasts or projections can materially alter the conclusions of an expert and can often be the cause of large differences between experts.

An attorney and an expert should first assure the efficacy of the expert's own forecasts or projections and then review and determine the efficacy of the opposing expert's forecasts or projections.

Forecast vs. Projection

To help understand the concepts better, let's look at the difference between a forecast and a projection using the AICPA definitions in its Standard for Financial Forecasts and Projections.

Financial forecast - Prospective financial statements that present, to the best of the responsible party's knowledge and belief, an entity's expected financial position, results of operations, and cash flows. A financial forecast is based on the responsible party's assumptions reflecting the conditions it expects to exist and the course of action it expects to take.

Financial projection - Prospective financial statements that present, to the best of the responsible party's knowledge and belief, given one or more hypothetical assumptions, an entity's expected financial position, results of operations, and cash flows. A financial projection is sometimes prepared to present one or more hypothetical courses of action for evaluation, as in response to a question such as, "What would happen if?" A financial projection is based on the responsible party's assumptions reflecting conditions it expects would exist and the course of action it expects would be taken, given one or more hypothetical assumptions.

To distill this, a forecast is the expert's opinion as to what the entity's expected financial position will begiven the conditions in existence.

On the other hand, a projection is the expert's opinion as to what the financial position of the entity would be given a set of hypothetical assumptions.

Potential Uses in Litigation

When calculating economic damages, it's often necessary for the expert to use a projection that reflects what the conditions hypothetically would have been "but for" the interference that is the subject of the claim.

When a valuation is performed as part of a litigation -- such as the loss of business value or the valuing of a business interest in divorce -- a forecast is typically necessary to properly derive value. A business valuation requires the expert to estimate the present value of expected future benefits.

Working Together to Gauge Efficacy

Together, the attorney and expert should determine whether a forecast or a projection is appropriate for the situation at hand. The expert can also help the attorney evaluate whether the opposing expert has properly used a forecast or a projection.

Note: A CPA expert is not required to follow the Standard for Financial Forecasts and Projections in a litigation, but it is still important that any expert (CPA or not) knows the difference between a forecast and a projection and properly uses the concepts in his or her calculation of damages or value.

In addition, the attorney and the expert should insure that the assumptions used for either a forecast or projection are appropriate. This can mean reviewing key assumptions -- such as future expectations about sales, cost of sales and overhead costs -- on an item-by-item basis. A similar review should be conducted on the opposing expert's assumptions. In turn, these reviews can help determine the underlying sources of differences in the experts' final conclusions.

Getting It Right

Some people use the terms "forecast" and "projection" interchangeably. But in an accounting context, there's an important distinction. Understanding the difference between a forecast and projection -- and when it's appropriate to use each type of report -- is the key to arriving at an accurate and reliable estimate of damages or value.

For more information contact Doug Sosnowski at 716-856-3428.

 


DOUGLAS P. SOSNOWSKI, CPA/ABV, ASA, CFF
dsosnowski@briscon.com

Douglas P. Sosnowski provides business valuation, forensic accounting, and litigation support services for Brisbane Consulting Group. He has extensive valuation experience and has served as an expert witness, testifying in courts of law throughout the state of New York. Doug has experience consulting with publicly traded entities and valuing a variety of closely held companies in connection with mergers, acquisition and divestitures, business combinations, estate and gift tax planning, ESOPs and purchase price allocations. He also has experience in the quantification of lost income in determining business interruption claims for insurance adjusters. Doug is a member of the American Institute of Certified Public Accountants, New York State Society of Certified Public Accountants and the American Society of Appraisers. Doug is a licensed financial advisor holding Series 7 and 66 securities licenses. He graduated with honors from the State University of New York at Buffalo earning his Bachelor of Science degree in business administration with concentrations in accounting and finance.