LOST PROFIT CALCULATIONS

Valuation analysts at times are engaged to quantify damages that a business or individual alleges to have occurred as a result of some breach of a contract or duty by another party. The lawyers involved typically must establish that the defendant was liable and that the plaintiff suffered damages as a result of the defendant's actions, with the business appraiser helping to quantify the damages so incurred. In determining commercial damages, the question arises as to whether the appropriate measure of damages is lost profits or lost value. The nature of the alleged damages helps to determine the appropriate measure of damages. If a business experiences a temporary reduction in sales or profits as a result of certain actions but recovers, then a lost profits calculation might be more appropriate. On the other end of the spectrum, if a business fails as a result of certain actions, then the lost value of the business might be the more appropriate measure.

Performing lost profits calculations and business valuations often entails applying similar approaches and methodologies (e.g., discounted cash flow method), but important differences exist between the two disciplines. These differences include, but are not limited to, the following:

• Time period - Lost profits calculations are typically for a finite period and are based upon a standard of reasonable certainty. Business valuations are typically assumed to continue into perpetuity.
• Incremental focus - Lost profits calculations are typically based on lost incremental profit taking into account costs that would have been incurred had the revenues been realized. The focus of business valuations is assessing the value of all expected future profits.
• Income taxes - Lost profits calculations are usually before corporate and individual income taxes, as the objective is to enable the damaged party to be made whole. Business valuations are typically prepared on an after corporate tax basis.
• Subsequent events - Lost profits calculations typically take into account all information known through the trial date. Business valuations typically only consider information known or reasonably knowable as of the valuation date.