New Jersey Forensic Accounting Services: Calculation of Lost Profits

Video Transcript 

My name's Robert Bonavito, New Jersey forensic accountant. This video is part of a series of videos where I discuss forensic accounting topics for educational purposes only. If this was a litigated matter, I would take a different approach, have different conclusions based on different facts and circumstances. Jersey forensic accountant, today's video topic is calculation of lost-profits.

Lost-profit calculation is a big area where forensic accountants are in great need, and because it's a pretty complex area, and usually if you have a lost-profits case, it's pretty important to be able to prove lost-profits because that's why you're going to court. And when you're proving lost-profits, it usually has something to do with a tort case, or a breach of contract, or a contract dispute. And what we would do, is we would go in and analyze the contract to determine if there was damages. The two main methods that we use in my office are is the before and after method and a yard stick method.

The before and after method of calculating lost-profits is to calculate the profits you were making before, compared to the profits you were making after the breach. And if, you know, the profits went down 30%, 40%, and we can say, "Well, the reason the profits went down is because of this contract dispute," or "this issue resulted in lost-profits." Or if it's a new business that never got off the ground, we use the yard stick approach, which says, "The profits in our business at this location earned, you know, 30%, 40%, and the one we started up but went outta business would've been as similar to the other one. We would've made 30%, 40% on our profits." We project income, we calculate profits, we present value of those, and we come up with the damage calculation.

When you...to do these...it's pretty complex how to calculate lost-profits because you have fixed cost and variable cost. Fixed cost typically don't go away. If you have rent, you have a five-year lease, the rent doesn't go away, whether there's business income or not. Other costs like employees, electricity, those costs will go down. And that's a big part of our job, is projecting income, determining fixed cost and variable cost to come up with the lost-profits. I mean, a case that comes to mind is, in this area, was a national furniture company came to us and they said, "Bob, we had...we put in, you know, $10 million in this location on a major highway with access off a major thoroughfare. And we rented the space for 10 years, and we put one of our...you know, this method of...this furniture store, you know, we've done this many times in many parts of the country and it usually makes X amount of money, and we kinda tell, because we've done this so often, how much money we should make outta this location."

But what happened was the way that the furniture store was situated on the highway, there was an access ramp into this shopping center where this furniture store was located. And what happened is the state came in and condemned the off-ramp. And we were able to find out that the landlord knew of this condemnation, which meant that people who wanted to go store could no longer make a right, they had to go down two miles, make a left, and a right, and it was a lot harder to access the furniture store because they can no longer make that simple right to get there. And we did this with a team of experts, because they had a major sign on the highway, and what we were able to show, we brought in a sign expert, and he was able to show that this sign on the highway with X amount of people going by, would account for, you know, 15 or 20 people a day walking into the store. The sign alone. And of those 15 or 20 people, 10 people would buy. And, you know, maybe they'd buy a living room set, maybe they'd buy a bedroom set. It was a multi-thousand dollar purchase. And we were able to demonstrate that once the off-ramp was closed, the sign had to come down too because they condemned that. We lost the sign and we lost access. And the business was open two years before it was affected. I mean, it was...you could see a downward side...slide in sales as the construction progressed, and then sales just plummeted and naturally they couldn't afford their rent.

And so what we were doing as forensic accounting in this lost-profits analysis, we were taking, again, we were able to prove pretty reasonably that as a result of them closing down this highway and removing the sign, it was really correlated to the decline in sales. And we were able to show that in court, we were able to calculate damages based on before the sign was removed and the access was removed and after, before and after method. And we also had the yard stick method, because this company had a lot of other stores that we could say, "Well this store is similar to the one in Alabama or California." And we used both methods, we testified, we were successful.

My name's Robert Bonavito. If you have any questions on this video, feel free to call me or email me.

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