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Is Your Business Worth More Than Zero?

B. M. Brogden, Jr., Chief Deputy Legal Counsel

I went to lunch one day and ended up in a slow line at my favorite fast food outlet. The fellow next to me in that line was a respected licensee with a similar taste in traditional southern cuisine. We fell to “talking shop,” including the various methods for valuing an ongoing real estate brokerage business. At the end of a complex discussion of ratios and formulas, he explained, “Now if the trust account is short, the value of the business is either zero or a negative number.”

OK. Simple. According to at least one licensee, if your trust account is short, no matter how many clients, contracts and other assets you have, your business is worthless. Does that mean that if the bank statement shows money in the trust account, you can just stop there? No!

Enough Money
Why? Just because you have what seems like enough money in the trust account doesn’t mean you are in compliance. Consider the following example:

Firm A does not correctly utilize an owner ledger system that balances to a journal, or perform the monthly reconciliation required by Commission rule. It is only when the Commission trust account auditor comes around for a visit that the BIC finds out that the firm routinely pays out earnest money from the trust account for closings when it is not actually holding that money because the deposit went to a builder. One would expect this to show up pretty soon with bounced checks, so the BIC at first can’t believe this.

However, because the BIC also was not closely reviewing the trust account records, he also had not figured out that in other transactions, where the closing attorney had credited the earnest money held by the firm in the trust account against the total amount of commission due at closing, Firm A had never taken those funds out of the trust account after closing. So, by unlawful commingling (which kept money belonging to the firm in the trust account instead of being transferred to its operating account, reducing the actual amount of the firm income it could spend), the BIC managed to keep himself from finding out that trust money was being misapplied!

I don’t have to make this example up — it happens all too often. Done intentionally, this kind of misconduct can be used by crooks to hide trust account embezzlement for awhile. Done unintentionally, the BIC disguises the value of the firm with a pretense of solvency. Either way, the licenses of the firm and its BIC are at risk, as is the money of the firm’s clients and customers.

The heart of the problem is that all too often, the BIC views the trust account record keeping as a burden or a homework assignment in a foreign language. Yet, how can the BIC know if the business itself is healthy and profitable if he or she really does not understand what the trust account is doing on a regular basis? Brokers-in-Charge have a responsibility to understand their office bookkeeping systems and to know what’s going on.

Ledger System

The key is that the BIC must understand how a ledger system is created, how the ledger system relates to the journal, and that simply balancing the bank statement to the journal is only the first step in the monthly reconciliation. The total of all the pending or open ledger balances should equal the reconciled bank balance which should equal the running balance on the journal. If to reach this balance, the firm must include negative balances on owner ledgers, there is a serious problem. No owner ledgers should ever have a negative balance.

If you are the BIC or bookkeeper and if the concepts described above don’t make sense to you, it’s time to take the trust account course and other educational programs to get yourself up to speed. Otherwise, you may wind up asking yourself, “Why isn’t my business worth more than zero?”

This article came from the February 2002-Vol32-4 edition of the bulletin.