Lost profits
Lost profits are economic damages caused by a disruption in business operations. The damages can be the result of a variety of factors, some of which include patent infringement, breach of contract, liability caused by an accident, negligent acts or physical damage to business property or equipment.
The need to quantify economic damages for the purposes of determining lost profits with reasonable certainty is a necessity for any case that seeks retribution against an offending party.
Loss Period
Lost revenues are typically calculated from the date when the defendant’s actions first impact the performance of the plaintiff’s business (“the incident”) to a specified date following the incident. This post-incident date can be based on the time period required for the plaintiff’s projected operating performance to return to a level it would have achieved but-for the defendant’s actions. This date can also be based on other factors such as the terms of a particular contract.
Calculation
Lost profit calculations do not typically include fixed gross profit expenses because lost profits are generally considered lost net profits, which are determined by subtracting the avoided costs (incremental expenses) from the estimated lost gross revenue. Fixed expenses, such as rent and salaries, are often not deducted because they are incurred regardless of the business activity that was lost.
Key Aspects of Lost Profit Calculations
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- Net Profits, Not Gross:
Courts and legal professionals usually focus on recovering lost net profits rather than gross profits or just lost revenue.
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- Estimating Lost Revenue:
The first step is to estimate the gross revenue that would have been generated had the wrongful act not occurred.
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- Subtracting Avoided Costs:
You then deduct the incremental costs that would have been incurred to produce that lost revenue. These are known as “saved” or “avoided” costs, such as the direct cost of goods sold and sales commissions.
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- Excluding Fixed Overhead:
Fixed expenses, like rent, insurance, and salaries, are generally not deducted. These are expenses that the business would have incurred even if the wrongful act hadn’t happened.
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- Focus on Direct Expenses:
The calculation centers on expenses directly related to the lost sales or services.
Why Gross Profit Expenses Are Not Deducted
Overstatement of Damages:
.Including all gross expenses would overstate the damages because it fails to account for fixed costs that the business did not save.
Principle of Damages:
The goal of lost profit damages is to put the plaintiff back in the position they would have been in had the wrongful act not occurred. This means accounting for the profit they would have made, not just the revenue before fixed overhead.
In summary, lost profit is calculated by taking estimated lost gross revenue and subtracting only the incremental costs directly associated with generating that revenue, not the business’s fixed overhead expenses.
Discount rate
When lost profits are in the future, say after the trial is scheduled, a discount rate is used to express the loss as a present value. As the saying goes, a dollar today is worth more than a dollar tomorrow. The discount rate in commercial cases is chosen to reflect the riskiness of a company’s future cash flows. As a result, the discount rate is higher than the risk-free rates typically used in personal injury and wrongful death cases.