A business owner cannot always be prepared for anything. On occasion, things will happen that can cause great disruption to a business, as well as a huge dent in company finances and profits.
While you can’t prepare for it, you can prepare against it. A forensic accountant has all the expertise and experience required to assist a business owner with calculating lost profits and help them get back on their feet.
Of course, it is important not just to understand the basics of calculating lost profits, but also prove that you have a case in the first place. Remember that the burden of proof always rests with the claimant, so it is essential to seek specialist guidance to assess the validity of your claim. Thankfully, a forensic accountant can help with this too.
How to Prove Lost Profits
In order for a business owner to prove lost profits they must be able to establish three important details; the proximate cause behind the claim, whether it was possible to foresee the likelihood of lost profits, and the damages must be provable with reasonable certainty.
Lost profits are damages caused by some form of disruption to a business’s operation. These disruptions can vary from damage to property to breaches of contract.
Every case of lost profits is unique. However, it is important that you know what to look for if you wish to make a claim of your own.
Proximate Cause
Establishing proximate cause requires that the lost profits can be tied directly to the disruption to operations. Lost profits can only be recovered if they can be clearly shown to be direct results of another party’s wrongdoing.
Proving proximate cause can be difficult. Once a claimant is able to prove that another party has affected their profits, the burden typically passes over to the defendant, who will then have a rebuttal opportunity to attempt to prove that there were other factors that contributed to the damages, either entirely, or partially.
Foreseeability
Foreseeability seeks to establish not whether the lost profits were caused by an outside factor. It does not even seek to ascertain whether the loss itself was predictable, instead it establishes whether the particular loss and its effect on profits could be expected when signing the initial contracts.
If the effect on company profits could not be deemed as foreseeable when signing the contract on the services/employment/establishment etc. then it can be difficult to prove that the defendant is guilty of directly causing lost profits due to negligent action.
To establish whether lost profits were foreseeable, courts will look at the exact terms of any relevant contracts, as well as the industry standards, and any other circumstances besides.
Reasonable Certainty
The rule of reasonable certainty dictates that lost profits can never be calculated to the penny, and therefore can never be totally accurate. For this reason, lost profit calculations do not need to be perfect as long as sufficient evidence exists to base and support a rational deduction with reasonable certainty.
During this stage, it is fairly common for courts to expect a clear distinction between proof of profits without the disruption, and the amount of damages sustained. Generally the onus of expectation is more on providing evidence that proves expected profits would have taken place, rather than calculations regarding the value of profits lost.
Ways to Calculate Lost Profits
Calculating lost profits is, in essence, a ‘but for’ estimate of how the business may have performed had there been no disruption. Each lost profits case is unique, and the calculation methods can differ. However, considerations such as establishing the time period, and determining lost value and savings made should remain constant for the most accurate figure.
Establish the Correct Time Period
The first step to calculating lost profits is to determine the time period during which the losses took place. In most cases, this will start on the date of the interruption, and finish when business has been able to return to normality.
A business returning to normality constitutes when it can be seen as returning to levels consistent with performances prior to the disruption taking place.
This rigid timeframe of events will not always be the case, therefore calculations and analysis will need to take place to ensure reliability.
Understand the Business
An important step to consider when calculating lost profits is to gain a core understanding of the affected business. This can be done via the means of independent research, or alternatively, you can go directly to the source and interview owners and employees.
The goal of this stage is to ascertain exactly how the business was performing prior to the disruption; what are seasonal impacts on performance, are there any relevant economic and industry trends to factor into projections etc.
An investigator should also attempt to garner an understanding of production and operational capacities prior to the disruption, what were the inventory levels, and more.
Determine Lost Value
Once lost time has been established, it is important that you work out the approximate gross value of the lost goods/services.
Gross value is the rough price that the goods/service would have fetched had they been available to clients or consumers. Costs that would ordinarily have been incurred in the process such as workforce costs, any delivery or transport expenses, etc.
Establish Savings
This step involves working out any usual costs that have not been incurred as a direct result of the affecting disruption. A common example of a saving would be a business no longer needing to purchase large quantities of new stock. To determine lost profit, this saving would be deducted from the lost value.
Other alternative examples of costs saved during interruption would be commissions, rent/utilities, performance based bonuses, and more.
How Forensic Accountants Prepare a Lost Profits Damages Calculation
The vital skill a forensic accountant possesses when calculating lost profits is thoroughness. Appointing a forensic accountant to assist you guarantees that no stone will be left unturned, no data will fall through the gaps, no fact will go unconsidered; nothing will be missed at all in pursuit of the right result.
A forensic accountant will develop an appropriate plan of action for any lost profits claim — without one you could find your claim rebuffed as a result of something not considered.
As part of the plan, a thorough internal review will take place, a forensic accountant will interview all relevant personnel, review all internal policy and paperwork, as well as conduct a thorough examination of all conclusions before the claim is submitted so as to spot any possible errors or figures that could be unpicked.
A qualified forensic accountant also possesses the skills necessary to act as an expert in court should it be needed. A key part of the training and expertise of such a specialised accountant is their ability to present their findings in court; both accurately and in a relatable way.
A forensic accountant will be able to get their point across, including all relevant data and findings, while being able to present it in terms that everybody will be able to understand.
How Inquesta Can Help with Loss of Business Profits
If your business has suffered significant financial loss as a direct result of an inciting disruption out of your control, be it by a third party or a factor out of your hands, we can help.
The Inquesta team has amassed decades of experience supporting and assisting business through loss of profits and can provide an honest, accurate service.
Working with you and your insurers we can devise a detailed claim, assist with negotiations, act as an expert witness, and more.
Contact our team, or request a free consultation today to learn more about what we can do to assist you.