Lost profits analysis estimates the profits a business would have earned but for an alleged event or conduct, compared with the profits it actually earned or is expected to earn. The analysis requires more than identifying lost revenue; it also considers the costs associated with generating that revenue, the period of loss, and other factors affecting financial performance.
Insight Forensic & Valuation Services provides independent lost profits analysis, financial analysis, and expert services in commercial disputes. We analyze the financial records and other information relevant to developing or evaluating a lost profits claim.
Lost profits is one of several measures of loss considered under economic damages.
Lost Profits Analysis Services
Our services may include:
Lost profits calculations for past and future periods
Analysis of historical and projected financial performance
Development and evaluation of but-for financial performance
Analysis of lost revenue and avoided or incremental costs
Review and rebuttal of opposing lost profits analyses
Financial discovery and supporting document analysis
Expert reports, deposition, arbitration, and trial testimony
The scope and methodology of each analysis depend on the facts of the matter, available financial information, and applicable legal framework.
How Lost Profits Are Calculated
A lost profits analysis generally compares the financial results the business would have achieved absent the alleged event with the results actually achieved or expected.
The But-For Analysis
The but-for scenario estimates how the business would have performed if the alleged event had not occurred. This estimated performance is compared with actual financial results to identify the potential financial impact.
The but-for scenario should be supported by relevant financial and operational information, which may include:
Historical financial performance
Budgets and forecasts prepared before the alleged event
Customer and sales history
Industry and economic data
Performance of comparable products, locations, or business units
The appropriate approach depends on the business and the circumstances, and may rely on historical performance, forecasts, customer activity, market data, or a combination of these sources.
Lost Revenue vs. Lost Profits
Lost revenue and lost profits are not the same. If a business loses revenue, it may also avoid costs that otherwise would have been incurred to generate that revenue.
A lost profits analysis therefore considers the relationship between revenue and the associated costs. Depending on the business, relevant costs may include materials, labor, commissions, shipping, or other expenses that change with sales or production. The analysis may also consider additional costs incurred as a result of the alleged event.
The objective is to measure the financial effect on profits rather than treating lost sales as the amount of the loss.
Determining the Loss Period
The period over which lost profits are measured can materially affect the calculation. The analysis may consider when the alleged financial impact began, how long it continued, and whether or when the business's performance recovered.
Relevant factors may include changes in sales or customer activity, replacement customers or contracts, and market conditions during the period.
Counsel determines the legally applicable damages period; we analyze the financial information relevant to the period established for the assignment.
Factors Affecting Lost Profits
Business performance can change for many reasons, and not every difference between expected and actual results is necessarily attributable to the event at issue.
Depending on the circumstances, a lost profits analysis may consider:
Historical revenue growth and profitability
Changes in sales volume or pricing
Customer gains or losses
Customer concentration
Production or capacity constraints
Competition and market conditions
Industry and economic trends
Changes in operations, management, products, or services
Actions taken to reduce or offset the financial impact
These factors help evaluate whether the assumptions used in the but-for scenario are consistent with the business's actual circumstances and available information.
Future Lost Profits
In some matters, the alleged financial impact extends beyond the date of the analysis. Estimating future lost profits requires assumptions about how the business would have performed and how long the financial impact is expected to continue.
The analysis may consider expected revenue growth, profitability, customer activity, and market conditions.
Where appropriate under the applicable framework, future lost profits may also be discounted to present value.
Because future results are inherently uncertain, projections and other forward-looking assumptions should be evaluated against the information available and the circumstances of the business.
Financial Records & Supporting Information
A lost profits conclusion depends on the reliability of the financial information and assumptions underlying the calculation. Depending on the engagement, we may review:
Financial statements and tax returns
General ledgers and accounting records
Sales and customer data
Budgets and forecasts
Contracts, invoices, and purchase orders
Payroll and expense records
Operational and production data
Industry and economic information
Where records are incomplete or inconsistent, additional analysis may be necessary to reconcile the available information, understand the business's historical performance, and evaluate whether the assumptions underlying the lost profits calculation are consistent with the financial records and other contemporaneous documentation.
Where the underlying activity has to be reconstructed before it can be measured, that work is forensic accounting.
Review of Lost Profits Analyses
Lost profits calculations can vary significantly based on the assumptions and methods used. When reviewing an analysis prepared by another expert, we may evaluate areas such as:
Basis for the but-for scenario
Revenue and growth assumptions
Period of loss
Avoided and incremental costs
Mitigating or offsetting financial effects
Future lost profits assumptions
Industry and market data
Consistency with the underlying financial records
Differences between lost profits conclusions may result from different assumptions, methodologies, or interpretations of the available information. Our role is to evaluate whether the assumptions, methodology, and calculations are supported by the information available and are internally consistent.
Where the claim itself arises from an alleged breach, the measure of loss is set out under breach of contract disputes. Where the interest or the business as a whole has to be valued rather than its lost earnings, that is business valuation.
Lost Profits Expert Analysis
Insight Forensic & Valuation Services may serve in a consulting or testifying capacity depending on the needs of the engagement. Our work may include assisting with financial discovery, developing an independent lost profits analysis, reviewing an opposing expert's calculation, preparing an expert report, and providing deposition, arbitration, or trial testimony.
Counsel determines the applicable legal framework and legal issues relating to the claim. Our role is to independently analyze the relevant financial information, explain the assumptions and methodology used, and provide a supportable calculation of lost profits within the scope of the engagement.
The expert role across the whole of a matter, in either capacity, is described under litigation support.
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