By Jason Bogniard, MBA, ASA, CVA, EA | Principal, Business Valuation
If a business has been around long enough, chances are some misunderstanding or outright misconduct has happened with a vendor, customer, or employee. At times, these business disputes require some mediation or litigation process to help reach a resolution. At the heart of many business disputes is an alleged action that has monetarily damaged the complaining party.
Civil litigation disputes fall into one of two legal categories: tort or breach of contract actions. Tort actions are civil wrongs that result from an act or omission that give rise to injury to another entity. A breach of contract occurs when the terms of a legal written or oral contract have been violated to such an extent that the complaining party can sue for monetary damages or the enforcement of an action. A responsible and supported calculation of monetary damages is often the basis for imposing a liability on the parties responsible for causing the harm or breach.
So, how are civil litigation damages calculated?
Damages can be calculated with reasonable certainty, and are most often done so using “Lost Profits” as the measure of the alleged damages. Much like it sounds, Lost Profits represent the amount of money that the plaintiff requests the court to award to make them in order to offset any historical or future profits they were unable to earn due to the alleged actions of the defendant. Typically, Lost Profits are calculated in what is referred to as a “but-for-scenario,” meaning the plaintiff would have earned the calculated profits, but-for the alleged actions of the defendant.
Lost profits calculated under the but-for-scenario consist of expected income or cash flow (but-for profit) as measured by but-for revenues less avoidable expenses. The avoidable expenses represent the expense avoided as a result of the lost revenue not having been earned. The next step is to subtract the actual profits earned (or anticipated to be earned) from the but-for profits, the product of which are Lost Profits. If the damage period extends into the future periods, which many times is the case, then the future lost profits can be converted into current values through the use of present value discounting.
Next, we turn our attention to the methods for estimating but-for revenues. The analysis and calculation of expenses and costs in a lost profit calculation will be addressed in a future discussion..
Establishing a reliable measure of lost revenues is an important and, at times, challenging element of calculating lost profits. Factors that can complicate the but-for revenue calculation include business seasonality, one-time projects, and general economic and industry specific factors. Commonly accepted methodologies for calculating but-for-revenues include:
- The “before and after” method – This method compares the plaintiff’s actual revenue before the damage event with the plaintiff’s actual (presumably lower) revenue after the damage event. This methodology works well when a business has been in consistent operation for a number of years prior to the damage event.
- The “yardstick” method – This method uses a comparable “yardstick” to estimate what the revenues of the plaintiff’s business would have been but for the damage event. An example of a yardstick is the revenue earned at a plaintiff’s similar business at a different location, such as in a chain of restaurants.
- Underlying Contract method – This method uses the specific terms of a contract which requires specific performance. An example of the underlying contract method could include a minimum number of units to be sold per month at a fixed cost per unit.
Partnering with experienced damage experts can help ensure defensibility of any legal claims made, along with forecasting damages expected to be received. Apple Growth Partners’ litigation experts consist of trial-experienced professionals, utilizing the appropriate methodologies to estimate financial damages while collaborating with legal teams. Contact AGP’s litigation team to discuss further.