December 16, 2019

Evaluating Forecasts: Insight Public Company Audits Can Provide Experts, Attorneys, and Other Users of Valuation Reports

By Nicholas Parseghian, ASA, Director, Advisory Services

Evaluating Forecasts: Insight Public Company Audits Can Provide Experts, Attorneys, and Other Users of Valuation Reports Valuation, Forensic & Litigation Services

The prominence of fair value accounting has steadily increased within accounting standards. Accordingly, the process to audit fair value accounting has evolved, commensurate with the frequency and complexity of these estimates. Projected financial information (PFI), including management’s budgets, forecasts, and projections, represents a key input to develop fair value estimates and is widely recognized as presenting challenges to the audit process. As a result, fair value accounting is an area that often receives attention from the Public Company Accounting Oversight Board (PCAOB) inspections of the audit work over public company financial statements.

Inspections are used by the PCAOB to assess auditors’ compliance with professional standards, and the results of these inspections describe numerous instances wherein auditors did not evaluate the reasonableness of PFI. Although business valuation experts are not responsible for auditing PFI, the audit process and the results of PCAOB inspections can provide insight to business valuation experts who may need to evaluate PFI prepared by management in connection with a variety of purposes, including litigation, tax reporting and compliance, management planning, and employee stock ownership plan administration, as well as attorneys and other users of the valuation reports.

As a general rule, management is likely in the best position to prepare PFI. Outside of the world of fair value accounting, courts have recognized “that management is, as a general proposition, in the best position to know the business and, therefore, prepare projections” in the “ordinary course of business.”1 The PCAOB has expressed the need for auditors to understand management’s PFI, which is also relevant to the work of valuation experts. Understanding how and why the PFI was developed can help build a foundation upon which to analyze and assess the related risk of the PFI. Potential questions to better understand PFI may include:

  • Was PFI prepared in the normal course of business or in connection with the valuation? If the latter, could there be any preparer bias or effort to direct the valuation results to a more (or less) favorable conclusion?
  • What are the supporting assumptions underlying the PFI, and who within the management team provided input? For instance: did Sales and Marketing have a role in developing a demand and pricing forecast, or was the PFI the product only of Accounting and Finance personnel? This may lead to additional management interviews necessary to complete the valuation engagement.
  • From a qualitative perspective, do the assumptions reconcile with the overall business narrative and strategy? By way of example, the authors of this article performed a valuation in the context of shareholder litigation, and the PFI presented dramatically higher future revenue and growth than history would indicate. The increase presented by the opposing party hinged exclusively on the addition of two sales personnel, despite a lengthy operating history in which the business operations did not have any success in this regard.


From an audit perspective, PCAOB inspection reports make it clear that merely understanding how the PFI is developed is not sufficient. Adequate testing of PFI is a critical component of the audit process, which valuation experts and users of valuation reports can learn from. Areas of inquiry might include:

  • Revenue: Analyzing projected growth relative to the subject’s historical experience and industry benchmarks, including public company peer group expectations. To the extent the subject’s forecast does not align with benchmarks, how does management explain and reconcile the differences?
  • Profitability: Analyzing margins relative to historical experience, industry experience and ensuring changes on a prospective basis are realistic. Are future results expected to deviate due to product mix or pricing inputs? To the extent operating cost savings are forecast, is there a cost strategy or implementation plan which documents how management expects to realize the savings?
  • How do prior period forecasts compare to actuals? Is there a history of over- or understating expected performance? If yes, what might this infer regarding the overall reliability of the PFI and the subsequent impact on the discount rate?
  • Cash flow: Is the forecast realistic with respect to reinvestment in working capital and fixed assets? Are cash collection periods in line with the subject company’s historical experience? For instance, the authors have seen projections which result in a significantly shorter cash conversion cycle than attained historically, without any documented AR process to accelerate the collection of receivables or known flexibility from suppliers to extend payables.
  • Model check: Does the math and model work? On a number of occasions, we have been provided a balance sheet from management which fails to balance.


While an auditor’s scope is likely limited to evaluating PFI in the context of fair value accounting, valuation reports may rely on management-prepared PFI for a variety of other business valuation purposes. The audit process, including lessons learned from PCAOB inspections, provides useful insight for evaluating PFI in contexts outside of fair value accounting. The lists above are not exhaustive and only intended to provide potential topics of inquiry which can help valuation experts and users of valuation reports investigate management’s PFI, to ultimately determine whether the PFI is reliable for purposes of the valuation.


In re Appraisal of, Inc., 2015 WL 399726, at *18.


Nicholas  Parseghian

Nicholas Parseghian


  • Advisory
  • Boston, MA