A Random Walk during your due diligence is to test the Sales and Cost of Goods Sold (COGS) presented you by the seller of the business. You may often find this as the only approach as many small Internet Businesses are good at customer service and managing costs, but are less good at retaining a thorough accounting of their sales and purchases.
The reason a Random Walk through sales and COGS numbers works so well at detecting fraud is that numbers in most financial documents conform closely to Benford’s law, while assigned or randomly selected numbers don’t. When individuals commit fraud, they usually invent numbers. The digit patterns of invented numbers cause sets of data to appear unnatural when compared to the patterns predicted by Benford’s law. Depending on the type of Internet business, and the number of records, you may find selecting 2% to 10% of sales to test for validity is sufficient. Once you have traced the sale you will then want to trace the product that was delivered for that sale (assuming the business is inventory based or drop shipping).The Random Walk of a Publishing/Directory Internet business presents a simpler approach as only the sales must be verified, which typically involves viewing PayPal or similar online records.
The Random Walk of a Subcription based Internet business presents the most complicated form of verification. With a subscription business, which typically sells for higher mutiples of SDE (Seller’s Discretionary Earnings) due to the greater “predictability” of future earnings. When reviewing the records of this business you not only focus on sales, but on the revenue generated during the subscriber’s “life”; the number of visitors it takes to “convert” a visitor into a subscriber; and the “churn” (also referred to as “turnover” of subscribers.
Meaning the ratio between the number of new subscribers added to the number of subscribers that drop their subscription.
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