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BGBC: Calculating lost profits requires analysis

February 1, 2012
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By Howard I Gross, Steven W. Reed and Casey L. Higgs

Computing the lost profits of a business as a result of a wrongful act is a complex task. And many times, the question to ask is: “But for” a wrongful act, what would the profits be? What would the value be?

Generally, lost profits are claimed as part of economic damages in litigation. A lost profits calculation, or economic damages analysis, is often performed to estimate the profits that were lost, or damages suffered, as a result of the wrongful act. In Robert L. Dunn’s 6th Edition of “Recovery of Damages for Lost Profits,” he writes that there are three requirements for damages recovery:

• The damages must be proximately caused by the wrongful conduct;

• The damages must be proven with reasonable certainty; and

• The damages must have been foreseeable at the time the contract was made (only for contract claims).

In calculating lost profits, net profits are recoverable. Net profits include the revenue the plaintiff would have earned “but for” the loss, reduced by the costs associated with generating the revenues. Gross profits are normally recoverable when net and gross profits are the same or if there is minimal or no additional costs necessary to realize the profits.

An important factor requiring identification is the damage period. Typically, the damage period begins on the date of the loss and ends when the company returns to the profitability or to the level of cash flow that it would have been at “but for” the loss.

There are several methods used to calculate profits that would have been attained “but for” the loss:

• Before-and-after method – This method projects operating results based off historical operating results as if there was no loss and then compares it to the actual results during the loss period to determine the damages.

• The Yardstick Approach – Under this method, the operating results from the loss period are compared to the operating results for the same period of a similar company for comparison purposes. The difference is used to determine the damages.

• Sales Project (But for) Method – Operating results are projected during the loss period absent the loss as if the loss did not occur. The projections are then compared to the actual results to determine the damages.

Which method is most appropriate depends on the circumstances of the issues at hand. Oftentimes, the calculation can use a combination of all three methods. The types and timeframe of financial data to be analyzed (e.g., actual, projections, etc.), the availability of competitor and industry information, among other factors, are all items that need to be considered when choosing the most appropriate method. Performing insufficient analysis of financial information, using an inappropriate growth rate to determine projections, and insufficiently considering other relevant factors can negatively impact the lost profits calculation.

Once a method of assessing damages is determined, the stream of lost profits needs to be discounted to their present values. Determining the appropriate discount rate is critical as a very small change in the discount rate can severely increase or decrease the amount of the lost profits calculated.

The process for calculating lost profits is based in sound and thorough analysis, but also requires the use of reasonable judgment and estimates. For these reasons, assessing damages can be a lengthy process. It is critical to be as accurate as possible when estimating cost revenues, calculating the costs associated with generating revenues and determining the appropriate discount rate. The calculated damages should be reasonable, based on reliable information using an appropriate methodology and performed by an experienced expert.•

__________

Howard I Gross, CPA/ABV/CFF, CFP; Steven W. Reed, CPA/ABV; and Casey L. Higgs, CPA/CFF, CFE, CVA are with BGBC Partners, LLP – Litigation, Forensic and Business Valuation. Contact BGBC at 317-633-4700 or visit www.bgbc.com. The opinions expressed are those of the author.

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  1. It appears the police and prosecutors are allowed to change the rules halfway through the game to suit themselves. I am surprised that the congress has not yet eliminated the right to a trial in cases involving any type of forensic evidence. That would suit their foolish law and order police state views. I say we eliminate the statute of limitations for crimes committed by members of congress and other government employees. Of course they would never do that. They are all corrupt cowards!!!

  2. Poor Judge Brown probably thought that by slavishly serving the godz of the age her violations of 18th century concepts like due process and the rule of law would be overlooked. Mayhaps she was merely a Judge ahead of her time?

  3. in a lawyer discipline case Judge Brown, now removed, was presiding over a hearing about a lawyer accused of the supposedly heinous ethical violation of saying the words "Illegal immigrant." (IN re Barker) http://www.in.gov/judiciary/files/order-discipline-2013-55S00-1008-DI-429.pdf .... I wonder if when we compare the egregious violations of due process by Judge Brown, to her chiding of another lawyer for politically incorrectness, if there are any conclusions to be drawn about what kind of person, what kind of judge, what kind of apparatchik, is busy implementing the agenda of political correctness and making off-limits legit advocacy about an adverse party in a suit whose illegal alien status is relevant? I am just asking the question, the reader can make own conclsuion. Oh wait-- did I use the wrong adjective-- let me rephrase that, um undocumented alien?

  4. of course the bigger questions of whether or not the people want to pay for ANY bussing is off limits, due to the Supreme Court protecting the people from DEMOCRACY. Several decades hence from desegregation and bussing plans and we STILL need to be taking all this taxpayer money to combat mostly-imagined "discrimination" in the most obviously failed social program of the postwar period.

  5. You can put your photos anywhere you like... When someone steals it they know it doesn't belong to them. And, a man getting a divorce is automatically not a nice guy...? That's ridiculous. Since when is need of money a conflict of interest? That would mean that no one should have a job unless they are already financially solvent without a job... A photographer is also under no obligation to use a watermark (again, people know when a photo doesn't belong to them) or provide contact information. Hey, he didn't make it easy for me to pay him so I'll just take it! Well heck, might as well walk out of the grocery store with a cart full of food because the lines are too long and you don't find that convenient. "Only in Indiana." Oh, now you're passing judgement on an entire state... What state do you live in? I need to characterize everyone in your state as ignorant and opinionated. And the final bit of ignorance; assuming a photo anyone would want is lucky and then how much does your camera have to cost to make it a good photo, in your obviously relevant opinion?

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