Lost Profits and Your Business’s Road to Recovery
May 17, 2021
At a glance:
- The main takeaway: Lost profits are a critical component to litigating and recovering damages following an incident, but appropriately calculating those losses can be challenging.
- Impact on your business: If your business has suffered damages or operational disruptions, understanding causation and calculating lost profits may be an important step for your company’s recovery.
- Next steps: Accuracy is key, and there are many variables at play. The expertise of a forensic accountant may help ensure that you recover what you deserve.
If you’re currently seeking to recover damages to your business, Aprio’s Litigation Support & Forensic Accounting team can provide the expertise you need to find facts to support your case and calculate lost profits.
The full story:
One of the most crucial steps to recovering from damage to your business is accurately calculating your lost profits. Whether you’re litigating breach of contract, patent infringement, or some other type of damage, you must be able to quantify the damages to your business.
Determining lost profits frequently requires expert analysis to identify what profits would have been “but-for” the actions of the adverse party. Since the “but for” scenario didn’t actually occur, the “but for” study requires analysis, data and evidence to support the expert’s calculations. These expert “but for” profits are compared to the actual profits, with appropriate adjustments to calculate damages. Lost profits are steeped in technical specificity and must withstand attack from the other side, as well as scrutiny from a judge and/or jury.
This article won’t overwhelm you with specifics you don’t need to understand – that’s what forensic accountants are for – but it will help you understand the significance of lost profits on your business’s ultimate recovery.
An Introduction to Calculating Lost Profits
On the most basic level, lost profits are a calculation of the economic damages caused by a disruption to your operations. That calculation is derived from two separate factors: your business’s actual results during the loss period and the “but-for” results for that same period had the loss event not occurred. When you subtract your actual results from your“but-for” results, the difference equates to your lost profits.
“But-for” Results – Actual Results = Lost Profits
Of course, generating the amount for both your business’s actual results and your “but-for” results is where the majority of the complexity lies, which is why the process is best left to qualified forensic accountants. While methods and approaches vary, in many instances you can expect the process to follow these general steps:
- Gathering contextual information on the business,
- Identifying the loss period,
- Calculating the net sales value loss,
- Valuing the expenses that did not occur due to the disruption,
- Determining other potential saved expenses, and
- Investigating the actual results.
Understanding Lost Profits in Action
The information gathered through the process above allows a forensic accountant to calculate lost profits with a reasonable amount of certainty because it generates both the actual results and the “but-for” results for the loss period. It also provides insight into other critical variables, such as any potential cost savings that could offset the estimated lost revenue.
For instance, consider this scenario: a creative services agency (the Plaintiff) sues another agency (the Defendant) for using the Plaintiff’s trade secret information to win bids. In this scenario, the Plaintiff’s lost profits must also reflect the costs they saved by not winning those bids, such as hourly salaries, software expenses, and office supplies. Calculating the Plaintiff’s actual results and “but-for” results would require complex analyses of many variables before generating an accurate lost profits amount.
The bottom line
In reality, you don’t need to know how to calculate your business’s lost profits – leave that to the professionals – but you need to understand why lost profits are important. Calculating a specific and defensible amount is necessary for litigation and crucial to receiving your deserved retribution.
We covered the basics of when, why, and how to calculate lost profits, but this isn’t a process you want to simplify in practice. Make sure you receive the full recovery you deserve by working with a qualified forensic accountant. Aprio’s Litigation Support and Forensic Accounting team can help you accurately quantify your lost profits so your business can recover faster and move on to what’s next.
- Protect your company from losses with the right compliance program
- Do you know your intellectual property rights?
- Get to know Aprio’s Litigation Support and Forensic Accounting Services
Don’t underestimate the value of the damages to your company after an incident. Contact our team to start a conversation about accurately calculating your damages, including lost profits.
About the Author
Haley Beatty is a forensic accounting, financial crime reporting expert. Her specialties include Anti-Money Laundering (AML), Know Your Client (KYC) investigation and regulatory compliance. She has advised some of the largest financial institutions in the world and led teams of 500 investigators. Haley works closely with clients to establish and advance AML compliance, monitoring and reporting programs that exceed regulatory requirements. She has experience advising a broad spectrum of financial industry clients from FinTech companies to MSBs and transaction processors.