In Calculating Damages: Use Lost Revenue or Lost Profit?

By Heather Deskins, CPA/ABV/CFF, CFE, CVA

As financial experts, we are often asked to prepare a damage calculation in regard to a legal dispute. In our preliminary assessment of the claim, we analyze and theorize how to prepare the calculation and determine what documents we need to support the calculation. Once we receive the appropriate documentation, we are ready to work.

The first step in the calculation is to determine the damage period and how much potential revenue has been (or will be) lost. It’s important to have a good understanding of how revenue is generated by the damaged party. Once the lost revenue is calculated, there is still more work ahead.

The next step is to decide what expenses the damaged party would have incurred had they generated the lost revenue. These are avoided costs or incremental costs related to providing a good or service. For example, if a restaurant is claiming damages due to construction next door that blocked the pathway patrons use to access the restaurant, the lost revenue should be offset against any expenses the restaurant would have incurred, such as the cost of the food, wages for the additional servers, cooks and bus-boys that would have delivered the lost service. As you can see, I didn’t mention rent, utilities, and managers’ salary. These expenses are considered fixed and do not depend on the amount of revenue generated.

Only net lost profits (lost revenue – avoided cost = lost profits) are allowable as economic damages. This represents the amounts that are potentially recoverable and place the damaged party in a position that it would have been had the damage not occurred.

Can there be an instance where just lost revenues are used? Well, there is usually an exception to the rule. In this case, the exception arises when there are no avoided costs that offset the lost revenue. For example, if a property owner was able to rent office space at $15 a square foot, but due to an alleged incident, is only able to rent the space for $10 a square foot. In this case, all the expenses of owning and renting the space (i.e. the mortgage payment, legal fees, and utilities) all remain the same. The only item affected is the amount of rent the owner is able to collect.

Therefore, it’s important to understand how the business generates revenue and how specific expenses relate to the generation of revenue. If an avoided cost is inadvertently missed, the calculation could be significantly overstated and then the reliability of the calculation is in jeopardy.

If you have specific questions regarding a lost profits case, please give me a call.

Heather Deskins, CPA/ABV/CFF, CFE, CVA

Heather Deskins,

Managing Member
P.D. Eye Forensics, LLC