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Using Skepticism for Calculating Loss of Profits

Forensic accountants are often asked to calculate loss of profits during a financial dispute. This is because the level of loss is clearly going to be different in the eyes of the person suffering the loss compared to the person who may have been responsible for causing it. Equally, somebody claiming an insured loss may well be at odds with the insurer who is reluctant to pay a claim until it is supported by a credible valuation which is in turn underpinned by sound reasoning and documented evidence.

At Mark Jenner & Co Limited we are used to establishing the profitability of a business and why this may increase or decrease over time. Reasons such as growth, decline, business interruption, business failure and negligence can all impact the bottom line which in many operations can be as erratic as the direction the wind is blowing from.  Therefore we understand that the profits before and profits after comparison normally used to calculate losses during any period of reduced activity or even complete shutdown must be used along with a healthy serving of forensic accountant’s skepticism!

At its simplest, a claim may be based on an annual turnover well in excess of recent reported activity. Usually an independent view will suggest that historical data, taken as a simple or weighted average of a number of years, indicates that the level of the claim is too high and seek to reduce it accordingly. This may well be the case, and many profit calculations are adjusted in this way appropriately. But it may also be necessary to interrogate any reasons for a sudden jump in anticipated turnover, and business plans for during the period of profit lost considered. The business suffering the loss may have been gearing up for an immanent change in legislation by investing in advance of new opportunities being available. As a result of the business interruption the opportunity to get in early thus earning “super profits” has been lost. Not only is there a cost in investment wasted, but also the failure to earn additional profits.

Therefore, forensic accounting skepticism must be balanced by a full knowledge of the underlying facts surrounding a business.

You may be a start up company that has run into an unfortunate incident causing your business to fail. Establishing fault for this becomes a dispute that can be both protracted and stressful. What makes things harder is that you have little if any reported results with which to demonstrate the full extent of your losses, yet you have not only lost your investment and working capital but also the future revenue you had envisaged.

It is essential that your claim for losses takes account of the potential your business had. This needs more than an optimistic projected income but a full and independent appraisal of your business plan and feasibility reviews carried out before to started operations. If you had independent due diligence carried out in order to raise finance, this could form a pivotal part of establishing the potential viability and hence lost future profits of the business. If you started the business without a formal business plan, areas that would be included such as examination of the potential market, a discussion of the abilities of the proposers and detailed financial analyses will all have to be carried out by independent forensic accountants employing their usual measure of suspicion, cynicism, pessimism and as noted above…skepticism!

In this way a robust, well reasoned and entirely credible assessment of your losses can be presented within your dispute. This approach will produce a report that is acceptable to a claimant seeking recompense or an insured recovery of losses, but also to any respondent whose responsibility it will be to settle the claim if liability is established in due course.

Where there is a contract that has an impact on the matter, this may contain conditions for remuneration should the terms of the contract be breached by one of the parties. In this case the mechanism for calculating the loss might be clear. This means that the forensic accountancy work is simplified somewhat. However, in such circumstances Mark Jenner & Co would always perform an overview of the “real loss” as in the event, the contractual loss might well be exacerbated by further consequential losses. This is why the calculation of losses, while in some cases it may well be relatively simple, is never straight forward.