Lost Profits The Basics

LOST PROFITS CHAPTER 1

This lost profit discussion is based on my education, training and experience of over 40 years.

This is a series where we are going to discuss lost profits topics.

Lost profits calculations are counterfactual.

To calculate lost profits you compare the difference between the financial performance of the injured business to those that it should have earned but for some unlawful actions or events.

Calculating lost profits is complicated because it requires extensive knowledge of accounting, finance, marketing, economic principles, and much more.

The goal of lost profits calculation is to make the injured party whole for its losses.

It is not necessary to determine losses with absolute certainty, but they need to be supported with sufficient relevant data. I often have to remind judges that it is impossible to calculate lost profits with 100% certainty.

My formula for lost profits; is economic profits that it would have earned less variable cost. 

This is true because if you are unable to produce a product that means you do not have to spend money on the variable cost such as labor. However, you would have some fixed costs such as rent..

When we prepare lost profit cases they usually revolve around contracts, torts (commonly referred to as fraud or misrepresentation), patent infringements, antitrust work.

Key elements to lost profits

This is the legal requirement that the plaintiff must prove

Reasonable certainty

Foreseeability, damage to the plaintiff is predictable

Damage period

Mitigation

Time value of money

Post judgment interest

Calculating lost profits involves estimating the amount of money a business would have earned if not for a specific event or action that caused a disruption. This calculation is often needed in legal disputes, insurance claims, and business interruption cases. There are several methods to calculate lost profits, each suited to different scenarios and available data: 

1. Before-and-After Method

   - This method compares the business's profits before and after the event that caused the loss. It assumes that, but for the disruptive event, the business would have continued to earn profits similar to those before the event. This method is straightforward but may not account for external factors affecting profitability.

2. Yardstick Method

   - The yardstick method compares the performance of the affected business with that of similar businesses in the same industry and market that were not affected by the disruptive event. This approach is useful when the affected business does not have a history of stable profits or when external factors have influenced the market.

3. Before-and-During Method:

   - Similar to the before-and-after method, this approach compares the business's performance before the event and during the period affected by the event. It's useful when the disruptive event has a prolonged impact over time, allowing for adjustments in the calculation to reflect partial recovery or ongoing losses.

4. Market Projection Method:

   - This method uses forecasts and business plans made before the disruptive event to estimate future profits. It's often used when a new business or a new product line without a significant history of profits is affected. This method relies on the credibility of the projections and their alignment with industry standards.

5. Discounted Cash Flow (DCF) Analysis

   - DCF analysis calculates the present value of expected future cash flows that the business would have generated without the disruption. This method is comprehensive and accounts for the time value of money, making it suitable for long-term profit loss calculations. However, it requires detailed financial projections and an appropriate discount rate.

6. Incremental Profits Method:

   - This method focuses on the additional profits that would have been earned from specific contracts, projects, or transactions that were lost due to the disruptive event. It's useful in cases where the loss is tied to specific opportunities rather than the overall business operations.

Each method has its strengths and limitations, and the choice of method depends on the nature of the business, the type of disruption, the availability of data, and the specific circumstances of the case. Often, a combination of methods or adjustments to a single method may be necessary to accurately estimate lost profits.