Whether business damages are calculated by the financial expert as lost profits or lost business, the objective is to restore the plaintiff to the position it would have been –“but-for” the defendant’s actions that caused the damages. When calculating lost profits, damages are typically measured for a specific or limited period of time. In general, the loss is the difference between what the business would have produced during the loss period, minus what it actually did produce during this same time frame. All the business’s expenses are taken into consideration in both the “what would have happened” and “what did happen”scenarios.
Case law and statutes dictate what a plaintiff needs in order to demonstrate lost profits. It is the financial expert’s task to employ both a scientific and artistic interpretation of the facts and circumstances that will eventually tell a detailed, accurate story.
The approach to determine lost profits is multi-faceted and generally requires the following 6 steps:
- Calculate lost earnings by comparing profit history before and after a damaging event,
- Understand the subject company’s cost structure,
- Examine the calculated expenses for reasonableness,
- Determine causation (i.e. consider possible reasons for drop in sales),
- Examine how things such as economic conditions, marketplace demands and government regulations have impacted a sales loss,
- Present detailed information to support the assumed revenue, expense, and growth rates.
As an experienced practitioner, the steps of assessing lost profits can be simply stated; but more often than not, the process itself requires meticulous attention to detail and a sharp eye for any contradictory information. Often, one needs to step back to inquire about issues that arise during this endeavor.
Three that come to mind are as follows:
- What influence does an immature line of business affect the overall operations of the entity?
- How does a poor performing sector influence the results?
- How influential should projections and forecasts that materially differ from historical results be, and how should they be utilized?
The financial expert knows that the credibility relevant to projected income—and anticipated expenses—is absolutely critical in supporting a lost profits claim. The analyst works methodically from business plans, market surveys, income projections, and other evidence of projected revenues to estimate future receipts. One may use data from industry sources, comparable companies, market data or any other source that may help in predicting accompany’s financial results. It is imperative that the expert acquires in-depth knowledge of the subject company early in the process: its products, markets and competition, and the market forces to which it is subject.
In a case when an entire business is destroyed, the analyst’s task is still to determine the lost future cash flow. But in contrast to a lost profits case, the loss is now permanent. Just as in the lost profit calculation, the expert considers all of the subject company’s expenses in the “what would have happened” vs. “what did happen” scenarios. The fair market value of the subject company is determined based on the assumption that an earnings stream will continue into perpetuity.
So when the attorney considers whether a plaintiff may recover both lost profits and lost value, I can tell you of an important exception: when a business operates for a certain amount of time and then closes as a direct result of the defendant’s behavior, thereby incurring a period of lost profits followed by lost business. In this case, the courts have found no “double-counting” of the plaintiff’s allowable recovery.
Simply summarized, how does a lost profits case differ from a lost business case? Lost profits are usually measured over a specific time period (e.g. the estimated time it will take the plaintiff to restore “normal” profits).With lost business value, profits are projected into perpetuity. A lost profits analysis views a business from the perspective of a plaintiff; a business valuation views the business from the “hypothetical buyer’s” perspective.
Drawing from the analyst’s skills in finance, accounting and economics, the financial expert—reasonable and objective– can distill complex data into an understandable, accessible communication that can prove invaluable to the litigation team.
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