The efficacy of financial forecasts or projections that are used by an expert when they are making a valuation in a litigation proceeding is a point that can be missed. If these forecasts are off, they can be the cause of a large difference between experts.
It’s important for an attorney and an expert to assure the efficacy of the expert’s opinion before they review the opposing expert’s forecasts and projections.
Forecast vs. Projection
The AICPA definitions of forecasts and projections can help point out the differences between the two.
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.
Basically this means that a forecast is the expert’s opinion as to what the business’ financial position will be in the future, when taking into account the current conditions.
For a projection, the expert makes a judgement on the financial position of the business with a set of hypothetical assumptions.
Potential Uses in Litigation
When calculating economic damages, the expert usually will use a projection that shows what the financial conditions hypothetically would have been if not for the interference that is the subject of the claim.
A forecast is usually needed to derive value when the valuation is performed as part of a litigation. The valuation expert needs to estimate the present value of expected future benefits.
Working Together to Gauge Efficacy
In most cases the attorney and the expert figure out together whether a forecast or a projection is best in the given situation. The expert will also help the attorney decide if the opposing expert has correctly used a forecast or projection.
It is important to note that a CPA expert is not required to follow the Standard for Financial Forecasts and Projections in a litigation, but the expert must know the difference between a forecast and a projection, and use the correct concepts in their calculations of value or damages.
The attorney and the expert should review key assumptions on an item-by-item basis, and realize that the opposing experts and attorneys will be doing a similar review. These will help clarify any differences in the experts’ final calculations.
Getting It Right
People tend to use the words forecast and projection interchangeably. There is, however, and important distinction in the accounting world. Understanding these differences is key when obtaining an accurate and reliable estimate of value. To learn more about the expert’s role in valuations, schedule an appointment with Filler & Associates.