Determining the Length of a Damage Period

A critical question frequently encountered in damage cases is: How long will the damage period last? This issue applies to damage calculations for lost business profits as well as individual employment, personal injury and other related matters. Feeley & Driscoll can assist you with any forensic accounting services questions you may have. 

The follow-up question is: When will the damaged party return to the position it would have held but for the incident?

BUSINESS DAMAGES

A forensic specialist can assist you, in lost profit matters, with the art of projecting when a company may return to the "but for" position.  This involves several assumptions. As a simplified example, assume XYZ Co. had total sales of $900,000 in 1997, and had projected sales of $I million for 1998 and 10% annual sales growth thereafter. As a result of an incident, however, sales declined to $800,000 in 1998. Due to mitigation efforts and the fact that the company now has a lower sales base on which to project future growth percentages, management is projecting 15% annual sales growth for the next five years. Also assume, for simplicity, that the only variable expense is cost of sales and that the gross profit is 20%.

Given these two sets of base sales levels and sales growth projections, the company's damage period extends from 1998 to 2002. This begins with lost sales of $200,000 in 1998, which is the difference between the "but for" sales of $1 million and the actual sales (as a result of the incident) of $800,000.The lost sales diminish each succeeding year, with the damage period projected to end in 2003, when the company returns to the "but for" position with sales of about $1.6 million. Lost sales during the damage period amount to $710,000, which is the starting point for the calculation of lost profits. After determining the resulting differences in profits, the financial expert calculates the present value of past and future annual lost profits due to damages.

In this example, the assumed lost gross profit (assumed to be the annual damages) consists of 20% of each year's lost sales. The total damages amount is the present value of the lost profits, or $135,000.

A fixed-period contract in a lost-profit matter may dictate the damage period because damages are generally recoverable for the duration of a contract.  These forensic services and contracts can be reviewed by a litigation specialist to determine the damage period duration.  If it's a long-term contract and profits cannot be projected with reasonable certainty, the damage period may be limited. Generally, courts have allowed damages based only on a period in which profits are reasonably probable. Also, because customers tend to fluctuate and sales volume changes year to year, determining future sales requires a reasonable basis. A forensic accounting firm CPA can make this determination based on such factors as specific customer expectations, historical trends, industry projections, and lost customers and their purchases from competitors during the damage period. While no one specific method should be used in all cases, the method a forensic specialist selects should be reasonable and provide a basis for the future sales increase.

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