Executive Summary: How Lost Profits Are Calculated
- Lost profits calculations quantify the income a business would have earned but for a breach, business interruption, or other wrongful act — and require reasonable certainty, not speculation.
- The three most court-accepted methods are the before-and-after method, the yardstick (benchmark) method, and regression / econometric analysis; the right choice depends on data availability and case facts.
- Causation must be established first: the expert must isolate the defendant’s conduct from unrelated market, seasonal, or internal factors.
- The plaintiff has a duty to mitigate losses; a well-documented mitigation analysis strengthens the damages opinion and blunts common defense attacks.
- A defensible lost profits opinion traces every assumption to source documents — contracts, tax returns, general ledger, and bank records — and avoids double-counting revenue and avoided costs.
When Lost Profits Calculations Arise in Litigation
Lost profits calculations are most often requested in the following dispute contexts:
- Business interruption events: operations are partially or fully suspended due to physical damage, equipment failure, or other disruption tied to an alleged cause.
- 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.
- 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.
The “But-For World” and Establishing Causation
Before any lost profits calculation can begin, the damages expert must address causation: was the alleged wrongful act the proximate cause of the revenue decline? Courts reject lost profits opinions that fail to isolate the defendant’s conduct from independent factors such as:
- Broader economic recessions or industry downturns
- Seasonal revenue patterns unrelated to the event
- Internal operational problems that pre-dated the dispute
- Competition from new market entrants
The but-for world is the hypothetical performance the business would have achieved absent the wrongful conduct. The expert builds this benchmark from historical trends, comparable businesses, contracts, and market data — then documents why the benchmark is reliable and not speculative. For a detailed treatment of statistical causation analysis, see our post on proving causation in economic damage cases.
Accepted Lost Profits Calculation Methods
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.
Regression and Econometric Analysis
Uses statistical modeling to isolate the effect of the alleged wrongful act from other revenue drivers (seasonality, macro conditions, market trends). Regression analysis is increasingly used in complex commercial cases and business interruption disputes where multiple variables affect revenue simultaneously. See our guide on court-tested economic damage calculation methods for additional detail.
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.
Key Inputs and Documentation the Expert Needs
A well-supported lost profits analysis typically relies on the following documentation categories:
- Pre-disruption financial statements (income statements, balance sheets) and tax returns — typically three to five years of history
- General ledger detail, monthly management reports, and bank statements covering the disruption period
- Contracts, purchase orders, invoices, and customer communications that support projected revenue and pricing assumptions
- Operational records documenting capacity, production schedules, workforce utilization, capacity constraints, backlog/pipeline, and churn that support volumes and pricing assumptions
- Cost support to separate fixed vs. variable costs (vendor invoices, payroll registers, staffing schedules, and production reports)
- Budgets, forecasts, and budget-to-actual reports created in the ordinary course of business
- Mitigation evidence (replacement sales, substitute suppliers/customers, cost reductions, and incremental ‘extra expense’ incurred to reduce the loss)
The Reasonable Certainty Standard
Lost profits need not be proven with mathematical precision, but they must be established to a reasonable certainty. This standard — used in most U.S. jurisdictions — means the damages expert must provide a reliable, evidence-based estimate rather than speculation or conjecture. Courts will exclude opinions that:
- Rest on assumptions not traceable to the record
- Fail to account for alternative causes of the revenue decline
- Project losses based on aspirational rather than documented performance
The expert’s report and testimony should walk the finder of fact through every major assumption, its source document, and any sensitivity testing used to bound the estimate.
The Plaintiff’s Duty to Mitigate Lost Profits
In most jurisdictions, a plaintiff cannot recover damages that could have been avoided through reasonable effort. The mitigation analysis answers two questions: (1) what steps did the plaintiff take to reduce the loss, and (2) what additional steps were reasonably available? A credible lost profits opinion documents mitigation efforts and credits the defendant for avoided costs — variable expenses that were not incurred during the shutdown — to prevent double-counting. For a deeper look at how mitigation affects economic damages, see our post on the role of mitigation in economic damage calculations.
Illustrative Numeric Example
Assume a three-month business interruption 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 |
| Avoided variable costs (40% of lost revenue) | ($240,000) |
| Incremental mitigation expenses incurred | $30,000 |
| Net Lost Profits | $390,000 |
This is a simplified illustration. Actual calculations involve detailed variable cost analysis, tax considerations, and case-specific facts.
How Experts Document and Defend Assumptions
A lost profits opinion is only as strong as its paper trail. Forensic accounting experts working on lost profits typically prepare a workpaper file that:
- Ties every revenue and cost input to a source document (invoice, contract, tax return, bank statement)
- Identifies each assumption explicitly, states the basis for it, and acknowledges alternative assumptions tested in sensitivity analysis
- Documents the but-for benchmark construction and comparability analysis
- Reconciles the damages model to the company’s own contemporaneous financial records
- Addresses mitigation and avoidable costs as a standalone section
This documentation discipline is critical because opposing expert witnesses and cross-examining attorneys will target every unsupported assumption. See also: common attacks on economic damage experts and how to prepare a defensible opinion.
Common Pitfalls and Defense 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.
Working with a Lost Profits Expert Witness
When retaining a forensic accounting expert for lost profits analysis, attorneys should look for practitioners with litigation experience, CPA credentials (ideally ABV or CFF), and a track record of withstanding Daubert and expert exclusion challenges. Early engagement allows the expert to help identify the right calculation method, flag document gaps before discovery closes, and structure the opinion for maximum courtroom clarity.
The economic damages and lost profits expert witness team at Joey Friedman CPA PA works with attorneys across Florida on business interruption, commercial contract, and litigation support matters. Learn more about what attorneys should look for in a forensic accounting expert witness before retaining one.
Frequently Asked Questions About Lost Profits Calculations
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. Claiming lost revenue as lost profits overstates damages and is a common basis for expert exclusion.
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, or must they be exact?
Courts apply a “reasonable certainty” standard: the existence of damages must be established with certainty, but the exact amount may be estimated if based on competent evidence. Speculative or conjectural damage theories are excluded, but evidence-based expert estimates are routinely admitted.
What is the “but-for” standard in lost profits cases?
The but-for standard asks: what would the business have earned absent the wrongful conduct? The damages expert constructs a but-for benchmark using historical data, comparable businesses, contracts, and market evidence, then measures the gap between that benchmark and actual performance.
How does mitigation affect a lost profits claim?
The plaintiff must take reasonable steps to reduce losses. The expert quantifies both the plaintiff’s actual mitigation efforts and any avoided costs (variable costs not incurred during the loss period). Failure to mitigate can reduce or eliminate portions of a lost profits award.
What is the yardstick method for lost profits?
The yardstick method uses a comparable business or industry benchmark as a proxy for what the plaintiff business would have earned. It is most useful when the plaintiff lacks sufficient pre-disruption history. The key issue is comparability: the benchmark must be similar in geography, size, product mix, and market conditions.
What documents are needed to support a lost profits claim?
Core documents include: financial statements and tax returns (typically three to five years), monthly general ledger detail, bank statements, contracts and purchase orders, payroll and staffing records, budgets and forecasts, and any evidence of mitigation efforts (replacement sales, substitute supplier agreements, incremental expenses).
Sources
- Federal Rule of Evidence 702 (expert testimony reliability framework)
- AICPA – Statement on Standards for Forensic Services (SSFS No. 1)
- AICPA – Statement on Standards for Valuation Services (VS Section 100 / SSVS)
- International Glossary of Business Valuation Terms.
Work With a Lost Profits Expert
Contact the team at Joey Friedman CPA PA to discuss your lost profits damages needs. Our forensic accounting expert witness services include lost profits analysis, business interruption quantification, and expert testimony in Florida courts.
Disclaimer: This article is for informational purposes only and does not constitute legal advice. Outcomes depend on specific facts and circumstances.
