Calculation Engagements—A Post-Mortem Perspective

Calculation engagements require development standards

A proper calculation engagement requires planning, mutually agreed upon procedures, and adherence to professional standards. Otherwise, the valuation analyst and firm risk damaging their good name and reputation.

A Calculated Value is a useful tool and service offering for both valuator and client.  However, if not professionally executed, the calculation provides little value.  It does more harm than good.  While this should not come as any surprise to the active valuation analyst and practitioner, it continues to be a problem and issue within the valuation community.  I was recently reminded of the problem after completing a calculation engagement and later receiving a copy of the opposing analyst’s work from my client.  It was evident that a review was in order.

Post Mortem

Subject: Professional service business consisting of a co-owner, three employees, and a client base of three to four firms

Purpose: Calculation Report variance approximating $250,000

Basic Assumption: Non-advocacy

Cause:  Non-compliance or misinterpretation of professional standards relating to calculation engagements in the areas of documentation and development

The problem presented here is neither new nor surprising.  Jim Hitchner has addressed the topic on more than one occasion and offered suggestions and guidelines.  Even with that assistance, the problem persists and lies in the interpretation of standards and, particularly, development.

Many valuators take the position that there are no development standards in a calculation engagement.  They point out that the engagement explicitly states that the client and valuator will agree to specific approaches, methods, and the extent of selected procedures.  Is that really the best defense or response one can offer?  If so, the deliverable will be an expensively packaged, “back-of-the-envelope” calculation that will probably not meet the expectation of the client and certainly not professional standards.

Based on my review of professional standards and many calculation reports, it appears that practitioners find the standards relating to calculation engagements are not written as clearly or specifically as those addressing valuation engagements.  It’s almost as if calculation engagements were some hybrid form of valuation.  The devil is in the development.

Development

The American Society of Appraisers’ Business Valuation Standards states calculation standards nicely and politely.  The objective is to provide an approximate indication of value, and is based on consideration of only limited relevant information, collection of limited information, and performing limited analysis.  First, the key words here are relevant and limited.  Second, it points the appraiser to the collection of information, which again is described as relevant and necessary before the specific listing. The point is that there is nowhere the appraiser is given liberty to ignore research, discovery, and acquisition of relevant data and information necessary to meet the objective.  The depth of the information analysis is left to the judgment of the appraiser.

Similarly, the Statement on Standards for Valuation Services (SSVS) provides nearly the same guidelines, but in a not-so-orderly and almost convoluted fashion.  Paragraph 21(b), for example, provides for the agreed-upon approaches and methodology, but in a more limited form than a valuation engagement.  Paragraph 46 details the minimum considerations and ends in pointing the valuation analyst back to paragraphs 44 and 45 for a listing of documentation considerations.  It is paragraph 44, point or bullet one that directs the analyst even further back to paragraphs 25-30, where a more detailed list of documentation is enumerated for consideration.  It is this constant back-and-forth referencing within the text that creates a lack of continuity and ultimately, confusion for the analyst.  I believe it is here that many valuation analysts struggle in interpreting the directions, applicability, and relevance of data required of their calculation engagement.

Solution

Based on my analysis and review of calculation reports from some of the leaders in our profession, a simple answer is that the valuation analyst/appraiser must consider and incorporate information deemed relevant in meeting the objective of the calculation engagement and client’s expectation.  It is in effect a “mini valuation” reduced to a calculation engagement through agreed-upon limitations in approaches, methods, and data acquisitions.

Application Example

Based on the post mortem presented, the calculated variance would more than likely been minimal if the analyst:

1. Researched the business, operation, and industry classification
2. Interviewed the shareholder manager
3. Developed a cost of capital considering points one and two above
4. Adjusted compensation to market (readily available online at the professional association websites) as part of the Income Approach
5. Used a direct market database that included similar firms of similar size—if available—instead of the Guideline Public Company Method, using four companies that were capital-asset dependent

There is no getting around the proper application of a calculation engagement.  It requires pre-engagement planning, mutually agreed up procedures, and adherence to professional standards.  Otherwise, the analyst and firm risk their professional reputation and good name on a calculated value that is neither credible nor helpful to the client.  I believe that is too much to risk for a quick and minimal fee.  A cheap calculation invariably cuts corners, makes unsubstantiated assumptions, and glosses over operational and industry factors.   When properly executed under the appropriate circumstances, calculation engagements provide valuators and clients a valuable tool and service. Valuation analysts should take the time to understand the requirements of a calculation engagement, how to present them, how to execute them, and how to report them in order to achieve client respect and professional recognition.    A cheap calculation does none of the above, and offering a cheap service does not lend itself to value creation or becoming a trusted advisor.

Jeffrey Harwell, CVA, MAFF, CMEA, is principal of Harwell & Company, a Dallas/Fort Worth, Texas, business valuation, litigation support, and machinery and equipment professional advisory firm. As a valuation analyst, his time is exclusively devoted to providing answers and solutions to client problems in the complex area of valuation. The firm’s focus includes economic damage and litigation support. In addition, Mr. Harwell serves on the Chair of the Ambassador’s Editorial Board of the National Association of Certified Valuators and Analysts (NACVA) as well as its Standards and State Chapter Committee. Mr. Harwell serves as NACVA’s State Chapter President of Texas. Mr. Harwell can be reached at (817) 385-1866.