Tools an Economist Can Apply to Financial Statements to Identify Errors, Omissions, and Fraud in Business Valuations

Abstract

Often economists are asked to value businesses. Many times the information given the economist is minimal and of questionable value. Parties wishing to bias the valuation may provide data. The financial statements typically provided are balance sheets and income statements. These sources can be fraught with errors, omissions and even fraud. The cash flow statements derived from these statements can be misleading and any analysis from these spurious statements is sure to be questions. A set of tools exists that the economist can use to establish the reliability of these financial statements. The tool kit uses basic accounting and mathematical logic. This logic, teamed with basic accounting definitions and conventions, allows the economist some comfort that the statements provided for use in the business valuation are free of obvious misinformation. These tools can also help the economist uncover some less obvious irregularities. For the analysis to proceed, the economist must have two balance sheets and the intervening income statement. By applying the accounting conventions and definitions, real, probable and possible solutions are developed and explained. After examining the relationship between the financial statements, the economist is better able to value the business.