Executive Summary
Economic damages are the measurable financial losses attributed to an alleged wrongful act. In commercial litigation, the numbers typically hinge on a clear “but-for” framework: what would have happened absent the alleged conduct, compared to what actually happened.
Most commercial damages opinions fall into three core models: (1) lost profits, (2) diminished value, and (3) extra costs. Each model answers a different question—temporary income loss, permanent value loss, or incremental expenses—and each is vulnerable to specific challenges if assumptions are unsupported or the math is not traceable to source data.
This pillar guide explains when each model is typically used, accepted calculation frameworks, the documents most often required, common pitfalls opposing experts attack, and practical rebuttal strategies. A simple numeric example is included and designed to tie out step-by-step.
When This Issue Arises
Economic damage models are commonly used in disputes involving:
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Breach of contract (termination of supply, distribution, service, or licensing agreements).
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Business tort claims (interference, misappropriation, unfair competition, and related allegations).
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Fraud and financial misconduct matters (diversion of funds, phantom vendors, or manipulated reporting that affects performance).
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Business interruption and operational disruption disputes (including coverage and loss measurement issues).
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IP and technology disputes (lost profits, reasonable royalty considerations, and cost-based harm theories).
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Shareholder, partner, and member disputes where alleged conduct reduces economic returns or exit value.
Model selection often turns on duration: lost profits are typically used when the business continues operating and the harm is time-bounded, while diminished value is typically used when the harm is long-lasting or permanent (such as the destruction of a business line or the loss of a durable competitive advantage). Extra costs often appear alongside either model when the plaintiff incurred reasonable incremental expenses to mitigate the harm or continue operations.
Accepted Methods / Frameworks
Regardless of the model, a defensible damages framework usually addresses: (1) causation (why the alleged act caused the loss), (2) the measurement period, (3) the but-for benchmark, (4) mitigation and saved costs, and (5) present value discounting when future losses are claimed.
Common methods used for lost profits include:
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Before-and-after method: compares performance before and after the event, adjusted for unrelated factors.
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Yardstick/benchmark method: uses comparable businesses, locations, or industry data to estimate but-for performance.
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Market share method: estimates but-for sales based on market size and share (often used in IP and competition disputes).
Common approaches used for diminished value include:
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Income-based approaches (e.g., discounted cash flow) comparing value with and without the alleged harm.
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Market-based approaches using valuation multiples to estimate the change in business value attributable to the harm.
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Asset-based approaches when asset values and liabilities drive the economics (more common for asset-intensive or holding structures).
Extra costs are typically measured by identifying incremental expenses that were:
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Directly caused by the event,
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Reasonable in amount, and
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Not already captured elsewhere in the model (to avoid double counting).
Numeric example (illustrative): separating lost profits, extra costs, and (when appropriate) diminished value
Assume a contract breach eliminates expected annual incremental profit of $150,000 for three years while the business works to replace the revenue. Assume a 12% discount rate for present value. Also assume the business incurred $40,000 in one-time expedited shipping costs in Year 1 to mitigate disruption.
| Year | Lost profit | Present value (12%) |
|---|---|---|
| 1 | $150,000 | $133,929 |
| 2 | $150,000 | $119,579 |
| 3 | $150,000 | $106,767 |
| Total | $360,275 |
Present value of one-time extra costs in Year 1: $40,000 ÷ 1.12 ≈ $35,714. Total present value of (lost profits + extra costs) ≈ $360,275 + $35,714 = $395,989.
When diminished value may also apply: If the evidence supports that the harm continues beyond the three-year loss period (i.e., a permanent reduction in cash flow), a value-based measure can be used for the post-period portion of the harm. The key is to avoid double counting: do not claim the same dollars twice.
Illustration (not added to the $395,989 above): If the business permanently loses $120,000 of annual cash flow starting in Year 4, grows at 2% thereafter, and a 15% discount rate is appropriate, the value of that continuing loss (measured as of the end of Year 3) is approximately: $120,000 × 1.02 ÷ (0.15 − 0.02) ≈ $941,538. Discounted back three years at 15%, the present value is approximately $619,077. This type of calculation is often presented as a separate, non-overlapping component tied to the post-period effect.
Documents & Data Checklist
Damages opinions are only as strong as the underlying records. Commonly needed items include:
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Financial statements (3–5 years) and year-to-date results, with consistent account groupings over time.
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Business tax returns for the same period (including schedules) to corroborate entity-level income and structure.
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General ledger exports and transaction detail for key accounts (revenue, COGS, payroll, owner benefits, unusual journal entries).
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Bank statements and merchant processing detail to validate cash receipts and identify unrecorded activity.
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Customer contracts, pricing schedules, purchase orders, invoices, credit memos, and termination/cancellation communications.
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Cost support: vendor invoices, payroll registers, staffing plans, and documentation distinguishing fixed vs. variable costs.
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Budgets, forecasts, and budget-to-actual reporting used in ordinary-course business planning.
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Operational data (units sold, utilization, capacity constraints, churn, backlog/pipeline) tying financial results to business reality.
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Mitigation evidence: substitute contracts, replacement revenue, cost reductions, and incremental mitigation expenses.
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Industry and market benchmark data used to test reasonableness of growth, margins, and demand conditions.
Pitfalls / Common Errors + Rebuttal Strategies
Common issues that opposing experts and counsel target include:
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Causation gaps: attributing all decline to the alleged act without separating unrelated market, operational, or competitive factors.
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Lost revenue presented as lost profits: failing to deduct incremental costs or to model saved costs.
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Unsupported but-for assumptions: growth rates, margins, capacity, or market share assumptions not tied to evidence.
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Mitigation ignored: failing to address replacement revenue, substitute vendors/customers, or reasonable mitigation efforts.
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Double counting: layering lost profits and diminished value for the same period without a clear, non-overlapping bridge.
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Discount rate and tax mismatches: applying inconsistent tax bases or discount rates that do not match the cash-flow stream.
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Weak traceability: calculations that cannot be reconciled to the ledger, tax returns, banking, and contract terms.
Practical rebuttal strategies that strengthen defensibility include:
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Build a transparent bridge from source documents to each key input (contracts → volumes/pricing; payroll/vendor invoices → cost behavior; bank/merchant data → cash receipts).
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Separate (a) period losses (lost profits) from (b) post-period effects (diminished value) and show why they do not overlap.
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Use sensitivity ranges on the few assumptions that actually drive the outcome (growth, margin, discount rate, mitigation timing).
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Document saved costs and mitigation clearly; show the net effect on profit rather than focusing on gross revenue.
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Keep the math simple and reproducible: tables, schedules, and clear definitions are often more persuasive than complexity.
FAQ
What is the difference between lost profits and diminished value?
Lost profits measure income not earned over a finite period; diminished value measures a lasting reduction in business value when the harm is permanent or long-lived. The correct model depends primarily on duration and whether the business returns to its but-for trajectory.
Can a business claim both lost profits and diminished value?
Sometimes, but only if the components do not overlap. A common approach is to claim lost profits for the defined disruption period and a separate value-based measure for post-period effects, with a clear bridge showing no double counting.
How are extra costs treated in economic damage models?
Extra costs are typically added when they are incremental, reasonable, and directly caused by the event. They should not duplicate costs already embedded in the lost profits or value analysis.
What is a “but-for” analysis?
A but-for analysis compares actual results to a reasonable estimate of what would have occurred absent the alleged harmful event. The difference—after mitigation and saved costs—is the basis for measuring economic loss.
Do future losses need to be discounted to present value?
Generally, yes. Discounting converts future dollars into today’s dollars using an appropriate rate that reflects time value and risk consistent with the cash-flow stream being measured.
Who is typically qualified to calculate economic damages in commercial litigation?
Damages experts commonly include CPAs with forensic accounting and valuation experience and/or economists with litigation experience. Where the dispute turns on accounting records, normalization, and traceability, a CPA with forensic and valuation expertise is often a strong fit.
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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Federal Judicial Center — Reference materials on expert evidence and damages concepts (general guidance).
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International Glossary of Business Valuation Terms (common definitions).
CTA + Disclaimer
Contact the team at Joey Friedman CPA PA to discuss your economic damages needs.
Disclaimer: This article is for informational purposes only and does not constitute legal advice. Outcomes depend on specific facts and circumstances.
