We've made a mistake. The financial model that we prepared for our client's acquisition has an error in it. I discover this on Monday morning when one of my analysts, Dan, brings it to my attention.

 

"Knock-knock", he says while pretending to tap on my open office door. "Umm, Alan, we were doing some scenarios with the noodle model and it looks like there are some calculation problems in the later years."

 

He calls it the noodle model because we were valuing a company that makes noodles. "Uh-huh, what sort of calculation problems?" I ask.

Dan answers in standard financial analyst jargon: "It's to do with the linkages in the income statement and a misapplication of the accounting treatment for the tax loss carry forwards."

"Right, and what does that mean?"

"Well, it means that the net income for years five to 15 is probably incorrect. We're just checking it now."

Dan is an excellent financial analyst, but like so many analysts he can become so focused on detail as to miss the big picture, which in this case is whether or not we have screwed up. Or, rather, how badly have we have screwed up.

"Incorrect, too much or incorrect, too little?" I ask.

"Too much" he says. Bad news. We have overstated how much income the business produces and thus how much it is worth.

So our client probably paid too much for the business they just bought. There are two ways to deal with an error like this. The first is to call the client and tell them about it. The theory here is that it will reflect better on us if we own up to the mistake than if the client finds the error themselves. Of course, it would reflect even better on us if no-one ever knew at all.

Which brings us to the second option and that is to pretend that we never noticed and hope that the client never notices either. The trouble with this approach is that the client will almost certainly discover the error themselves at some point. Since they are running the business, they can see what the actual financial results are and compare them to the model. When they reach the years where the error lies, they should be able to work it out.

But maybe they won't. Maybe no one will ever know. Do I really want to tell them and risk the client taking legal action, writing nasty letters to the CEO demanding I be fired, or perhaps even speaking to reporters about how hopeless me and my team are? And seriously, how likely is it that the client even understood the financial model well enough to work out whatever it was that Dan was talking about?

Although this sounds rather like a dilemma, it isn't really. In business, there is no mistake that you can't make worse by not telling anyone about it. Making a mistake is one thing, covering one up is quite another. So I really have no choice, but I'm not looking forward to making the call.

"Hi Mike," I say to the guy at the client who managed the acquisition, the proud owner of an overpriced noodle business. "I need to talk to you about the financial model we worked with in our deal. It seems that there was a small error on a couple of the sheets that I think you ought to know about."

At the end of my explanation, all Mike says is: "OK. Thanks for letting me know." That's it. Not "what the hell is wrong with you!" Not "I'll see you never work again in this town!" not even "I'll see you in court".

In fact, months go by without me hearing anything else. I only found out what happened when I ran into Mike at an airport six months later. I couldn't resist asking him how he dealt with the error.

"I informed my staff to make adjustments to our internal model" he said.

"That's it? You weren't upset?" I asked, perhaps foolishly.

"Doesn't matter if I am upset, there was nothing to be gained from talking about it further. Do you think I wanted to tell my management that the acquisition I was in charge of was overpriced? And do you think my management would want to tell the board that the acquisition they recommended was overpriced? And do you think the board would want to inform the shareholders? To be frank, Alan, you would have been doing me a favour if you never even told me."

I'll remember that next time.