Executive Summary
Lost profits are a common form of economic damages when a business’s revenue-generating activity is interrupted by a contract breach, a business interruption event, or other alleged wrongful conduct.
A defensible lost profits analysis generally uses a “but-for” framework: estimate the profits the business would reasonably have earned absent the event, subtract what it actually earned during the loss period, and then adjust for costs that were avoided and for any mitigation that reduced the loss.
Because lost profits opinions are often tested in deposition and at trial, the calculation must be traceable to source documents (contracts, accounting records, banking, and operational data) and must avoid speculation, double counting, and unsupported assumptions.
When This Issue Arises
Lost profits calculations are most often requested in the following dispute contexts:
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Business interruption events: operations are partially or fully suspended due to physical damage, equipment failure, or other disruption tied to an alleged cause.
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Contract disputes: a supplier, customer, distributor, or service provider fails to perform, resulting in lost sales, delayed deliveries, or the loss of a specific contract stream.
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Insurance-related loss quantification: business interruption or extra expense claims require a documented measurement of lost business income and any incremental mitigation costs.
The appropriate loss period is case-specific. In general, the loss period runs from the start of the disruption through the point when operations should reasonably return to the but-for level, considering practical constraints such as repairs, supply chain re-start, staffing, and customer re-acquisition.
Accepted Methods / Frameworks
Courts and litigants typically expect lost profits opinions to address causation, the loss period, the but-for benchmark, mitigation, and (when future losses are claimed) present value discounting. Common methods include:
Before-and-after method
Uses the business’s own historical performance to estimate but-for results, then compares that benchmark to actual performance during the loss period. This method is often strongest when historical records are stable and the business did not experience unrelated shocks at the same time.
Yardstick (benchmark) method
Uses comparable businesses, comparable locations, or industry benchmarks as a proxy for but-for performance when the business’s own history is insufficient or not representative. The key dispute issue is whether the benchmark is truly comparable in products, geography, customer base, and operating scale.
Market share method
Estimates but-for sales by applying a documented market share percentage to total market demand during the loss period. This approach is more common when market data is robust and when industry-wide changes must be separated from defendant-specific effects.
Specific contract method
Calculates expected profits based on contract terms (pricing, quantities, timing) and the plaintiff’s incremental cost structure. This method can be persuasive when contracts are sufficiently specific and performance capacity is supported by evidence.
Numeric example (illustrative)
Assume a three-month disruption reduces sales compared to the but-for benchmark. Lost profits should reflect lost revenue net of saved (avoided) variable costs:
| Item | Amount |
|---|---|
| But-for revenue for loss period | $1,500,000 |
| Actual revenue during loss period | $900,000 |
| Lost revenue | $600,000 |
If incremental variable costs are 40% of revenue, then avoided costs associated with the $600,000 lost revenue are $240,000 ($600,000 × 40%).
Lost profits (illustrative) = $600,000 lost revenue − $240,000 avoided costs = $360,000.
Fixed costs that continued during the disruption (rent, core salaries, insurance) are typically not subtracted as “saved costs,” because they were not avoided.
Documents & Data Checklist
Efficient lost profits work starts with a focused document set that ties the claim to the business’s actual financial and operational reality:
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Financial statements (monthly/annual) and tax returns for at least 3–5 years, plus year-to-date results through the loss period.
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General ledger exports and transaction detail for revenue, cost of goods sold, payroll, and key expense accounts (including owner-related or discretionary items).
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Bank statements and merchant processing reports to corroborate cash receipts and identify timing or completeness issues.
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Customer and supplier contracts, purchase orders, invoices, credit memos, and communications showing cancellation, delay, or non-performance.
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Sales and operational reports (units sold, utilization, capacity constraints, backlog/pipeline, churn) that support volumes and pricing assumptions.
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Cost support to separate fixed vs. variable costs (vendor invoices, payroll registers, staffing schedules, and production reports).
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Budgets, forecasts, and budget-to-actual reports created in the ordinary course of business.
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Mitigation evidence (replacement sales, substitute suppliers/customers, cost reductions, and incremental ‘extra expense’ incurred to reduce the loss).
Common Pitfalls + Rebuttal Strategies
Overstating lost revenue without accounting for avoided costs
A frequent error is treating lost revenue as lost profits. A defensible model identifies which costs would have been incurred to generate the lost sales and subtracts only those costs that were actually avoided.
Misclassifying fixed and variable costs
Cost behavior often drives the result. The analysis should document variable cost rates with accounting records and operational data, and explain which costs continued regardless of volume.
Failing to isolate the true cause of the decline
The damages theory must separate defendant-caused effects from unrelated drivers (seasonality, new competition, macro conditions, internal operational issues). Benchmarking and sensitivity testing are common rebuttal tools.
Ignoring mitigation and replacement revenue
Opposing experts frequently challenge whether the plaintiff took reasonable steps to reduce losses. A strong analysis documents mitigation efforts and quantifies offsets such as replacement sales or substitute contracts.
Weak traceability and unsupported assumptions
Models that cannot be reconciled to contracts, the general ledger, banking, and operational metrics are vulnerable. Clear schedules that tie each key input to source evidence strengthen reliability under cross-examination.
FAQ
What is the difference between lost revenue and lost profits?
Lost revenue is the gross sales shortfall. Lost profits measure the net impact after subtracting costs that would have been incurred to generate those sales and were avoided during the loss period.
How is the loss period determined in litigation?
The loss period usually runs from the start of the disruption through the point when operations should reasonably return to the but-for level. The end date depends on facts such as repair timelines, supply chain constraints, and customer recovery.
Do courts allow estimated lost profits?
Often yes, but the estimate must be supported with reasonable certainty using reliable methods and data. Purely speculative assumptions or unsupported growth rates are common grounds for challenge.
How does mitigation affect the calculation?
Mitigation can reduce recoverable damages if replacement revenue, substitute contracts, or reasonable cost reductions offset the loss. A defensible model documents mitigation efforts and quantifies the offsets.
What is commonly challenged in a lost profits model?
Typical challenges focus on causation, the but-for benchmark, cost behavior (fixed vs. variable), seasonality or market trends, and the use of unsupported projections. Traceability to source documents is also a frequent attack point.
What role does a forensic accountant play in these cases?
A forensic accountant can validate the underlying accounting records, identify non-recurring or owner-specific items, and quantify lost profits using accepted methods. They may also evaluate opposing expert opinions and provide expert testimony when needed.
Sources
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Federal Rule of Evidence 702 (expert testimony reliability framework).
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AICPA — Statement on Standards for Forensic Services (SSFS No. 1).
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AICPA — Statement on Standards for Valuation Services (VS Section 100 / SSVS).
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International Glossary of Business Valuation Terms.
CTA + Disclaimer
Contact the team at Joey Friedman CPA PA to discuss your lost profits damages needs.
Disclaimer: This article is for informational purposes only and does not constitute legal advice. Outcomes depend on specific facts and circumstances.
