In litigation and business disputes, measuring the money is critical. Forensic accounting is how you do it with precision and credibility. This article explains how forensic accounting works to calculate lost profits and provide evidence in court.
Forensic accounting is accounting, auditing and investigative skills applied to financial records for use in legal proceedings. When measuring economic damages, forensic accountants use a systematic approach to calculate lost profits. This involves understanding the business, identifying the time period affected, calculating net sales lost and any savings. Forensic accountants also account for any profits made during the disruption to adjust the damages accordingly.
Understanding the Business
Forensic accounting requires a deep understanding of the business. At Cendrowski Corporate Advisors, our forensic accountants look at:
- Business model: How the company makes money.
- Industry trends: Market conditions and industry-specific factors.
- Historical financial performance: Past financial statements to establish baselines.
This gives us the insight to make informed decisions and realistic projections when calculating damages. For example, in a recent case with a manufacturing company, our forensic accounting team’s industry knowledge helped us identify seasonal sales patterns that impacted the final damage calculation.
Identifying Time Period Affected
Determining the exact time frame of financial impact is a key part of forensic accounting. This involves:
- The start date of the damaging event
- The duration of the impact
- The end date or ongoing nature of the damages
Our forensic accountants establish a solid time frame by reviewing financial records, contracts, and external factors that affected the business during that period.
Calculating Net Sales Lost
Once the time period is established, forensic accountants calculate lost sales using:
- Before-and-after method: Comparing sales before and after the event
- Yardstick method: Using other businesses or industry standards as a comparison
- Sales projection method: Forecasting sales based on historical data and market trends
Our forensic accountants consider external factors that may have impacted sales during this period, such as economic downturns or changes in consumer behavior. We use advanced statistical analysis to validate our sales projections so they hold up in court.
Considering Saved Expenses
An often overlooked part of the damage calculation is the consideration of expenses saved due to the business disruption. Forensic accountants must look at:
- Variable costs: Expenses that change with production or sales volume
- Semi-variable costs: Expenses with both fixed and variable components
- Fixed costs that could be eliminated: Ongoing expenses that could have been reduced or eliminated during the disruption
By accounting for these saved expenses, our forensic accountants ensure the damages are not overstated. For example, in a recent case with a restaurant chain, our team’s analysis of labor and food costs during the forced closure period impacted the final damage calculation.
Accounting for Profits Made During Disruption
Forensic accounting principles require any profits made during the time period to be included in the damage calculation. This ensures a fair and accurate calculation of the true financial impact. Our forensic accountants capture these profits by:
- Reviewing interim financial statements
- Reviewing sales records and invoices
- Examining cash flow statements
By accounting for these profits, we get a more complete and defensible picture of the economic damage.
Challenges in Forensic Accounting for Economic Damages
Forensic accounting for economic damages has its challenges:
- Incomplete or unreliable financial data
- Disputes over methodology or assumptions
- Complexity in separating the impact of the event from other factors
At Cendrowski Corporate Advisors, our forensic accountants use data analysis techniques, clear documentation of methodologies, and defensible calculations that hold up in court.
Consult Our Forensic Accountants at CCA
Forensic accounting is key to calculating economic damages in legal disputes. By following a structured approach that includes understanding the business, identifying the time period affected, calculating net sales lost, considering saved expenses, and accounting for profits made during disruption, forensic accountants deliver valuable information and evidence.
Cendrowski Corporate Advisors forensic accountants have the industry knowledge, technical skills and attention to detail to deliver economic damage calculations. Whether you are in litigation, a business dispute, or need expert witness testimony our forensic accounting services can help. Contact Cendrowski Corporate Advisors today to strengthen your case.