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Claims of Lost Profit
Overview of Lost Profits Analyses
In litigation, lost profits are typically claimed as an element of economic damages. Accountants typically prepare damages analyses to either:
- estimate the loss suffered by the plaintiff as a result of the defendant’s wrongful conduct; or
- refute the plaintiff’s alleged damages.
To prove damages, the plaintiff must show:
- the defendant’s wrongful conduct caused the loss;
- the amount of the loss can be estimated with reasonable certainty and
- the loss was a foreseeable consequence of the defendant’s actions.
Only lost net profits are permitted as recoverable damages. The lost net profit is generally computed by estimating the gross revenue that would have been earned but for the defendant’s wrongful conduct and subtracting “avoided costs” – incremental costs that would have been incurred by plaintiff in connection with the lost revenue. Any actual profits earned by plaintiff are then deducted from the net lost profits to compute the damages amount.
Lost profits can only be claimed over the “loss period.” The loss period can be computed based on a variety of indicators, depending on the nature of the case. For example, statutory requirements, industry customs and contract terms can all dictate the loss period for the purposes of calculating lost profits. Oftentimes, the length of the loss period is a source of contention for battling experts in litigation, with the plaintiff claiming a longer loss period and the defendant claiming a shorter one.
Methods of Calculating Lost Profits
Calculating lost profits requires a two-prong analysis: first, calculate the lost revenues and second, calculate the cost associated with generating the lost revenues. The difference between the two generally constitutes the lost profits.
Calculating Lost Revenue
Methods generally used to calculate lost revenue include:
- The “Before and After” method
- The “Yardstick” (or “Benchmark”) method
- Analysis of the underlying contract
- Accounting of the defendant’s profits
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