Peter Gampel, director of forensic, litigation and valuation services with Fiske & Company.

A forensic accountant or a business valuator is often presented with management’s forecast. What degree of reliability can that person place on the forecast for either a valuation of a business or for a determination of lost profit for business damages? That depends.

Take for example the case of Cargotec Corporation v. Logan Industries, Fourteenth Court of Appeals No. 14-17-00213-CV. Cargotec and Logan had entered into a letter of intent (LOI) whereby Cargotec would acquire Logan’s assets. The transaction was not consummated after a lengthy due diligence period and Logan accused Cargotec of stealing customers and trade secrets and was awarded $12.7 million of damages. On appeal, challenges were made to the testimony of Logan’s damages expert who was a CPA and who was also accredited in business valuation.

The essence for the determination of damages and lost business value hinged on the expert’s reliance on management’s projections. Although the expert reviewed substantial documentation such as the business plan, tax returns, financial statements, economic and industry information, he provided no substantiation for the projections. Components of the projection such as source of revenue and profitability by type of customer, gross profit targets, likelihood of business expansion upon which the projections were predicated, were not addressed. Consequently, the appeals court rejected the expert’s opinions and reversed the decision on the basis that the expert did not demonstrate that the assumptions in the business plan’s projections were reasonable.

Management is not precluded from preparing any type of forecast they wish based upon their own purposes. It is quite often the case that aggressive revenue forecasts or budgets, i.e., the proverbial “stretch budget” is prepared to encourage sales staff to reach certain sales goals. However, these unattainable forecasts are quite often utilized as a medium by management to obtain a desired result. When experts are involved in the process and are requested to either value a business or determine lost profit, the necessity for intense scrutiny of these forecasts is mandatory. See, for example, Susan Fixel v. Rosenthal & Rosenthal, 921 So. 2d 43, 31 Fla L. Weekly D342, where unsupportable forecasts were used for a start-up business and Sostchin v. Doll Enterprises, 847 So. 2d 1123 (Fla. 3d DCA 2003), where an aggressive forecast was presented even though the business had modest historical profits. An expert who does not provide proper substantiation lacks the objectivity that is required by that expert.

Situations like this often occur. This is especially true when start-up companies are involved. Since they have either no track record or limited track record of revenue and profitability, it is often difficult if not impossible for the appraiser or damages expert to gauge the likelihood of the business achieving its targeted forecast. In a court of law, an improper validation of a forecast for business damages can have serious adverse repercussions. Similarly, if a valuation is utilized for purposes of attracting investors to the business, an overly aggressive forecast that does not materialize can also result in potential shareholder litigation. Deals are often structured with “earn-out” provisions that have a means to take some of the guesswork or expectations out of a forecast and determine total purchase price through actual results in the post-acquisition period.

Oftentimes, management will prepare a very aggressive forecast with escalating revenues and profitability where the business had never previously demonstrated any consistent level of profits. From an expert’s perspective, proper due diligence and analysis must be undertaken before a forecast can be relied upon. The forecast should be management’s forecast and not the expert’s forecast. In smaller owner-managed business budgets or forecasts may not even be prepared. The appraiser or expert can assist in building the forecast but it must be based upon the underlying assumptions that management provides and not the input of that expert. Whether a company routinely prepares forecasts or not requires the expert to diligently question and analyze the components on which the forecast is derived.

For example, a five-year forecast that contains year-over-year increases in revenue needs to be challenged. What is the source of the additional revenue? Does it emanate from existing customers or new customers? If the former, what is the basis for that? What are the historical trends of revenue with that customer? Is there a contractual relationship and therefore obligation to purchase? If the latter, are there new contracts signed that will generate the intended revenue and how does one assess that degree of revenue generation? What about a new product or service that will increase revenues? Has the business encountered discontinued or reduced products and services. Have these financial consequences been properly factored into the forecast? What about competition? In technology-related businesses, innovation and obsolescence are significant concerns. If management can provide answers and appropriate documentation where required, then reliance can be placed upon that source. If, however, management cannot, then the forecast should be ratcheted down to a more defined and reasonable basis. The same line of questioning would apply equally to gross margin analysis, overhead and capital expenditure requirements.

The longer the period of the forecast, the more difficult to assess it reliably. For many businesses it is often difficult to predict beyond one year let alone three or especially five years.

Generally, greater reliance can be placed on a forecast when the company has regularly prepared forecasts and the expert can do a look back to compare the actual results against the previously prepared forecasts. Since there is a great deal of uncertainly with any forecast, the expert would have to risk assess the forecast. In a business valuation or business damages analysis, that would be done through the determination of the applicable discount rate to be applied to the stream of cash flows. The greater the risk of attaining the results in the forecast, the higher the discount rate. That will then result in a lower valuation for the business or reduced lost profits from the damages analysis.

It should be noted that a forecast and projection are often viewed as synonymous and interchangeable. That is incorrect. A forecast is management’s best estimate of the likely outcome or expectation that management has whereas a projection is a what-if or hypothetical departure from the likely or intended outcome. A budget on the other hand is generally for a one-year period with specific requirements.

Substantiation of the forecast is the key for the expert when working on a valuation or litigation assignment. Without proper substantiation, adverse implications for all concerned will prevail.

Peter Gampel is the director of forensic, litigation and valuation services at Fiske & Company, a full-service accounting and consulting firm offering business valuation, litigation support and forensic accounting. Established in 1972, Fiske & Company has offices in Fort Lauderdale, Kendall, downtown Miami and Boca Raton. Visit for more information.