Understanding Economic Damages Calculation: Lost Profits vs. Lost Business Value

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When a plaintiff seeks compensation from a defendant for economic damages resulting from a breach of contract or other wrongful actions, damage experts need to consider the facts of the case to determine the most appropriate measure of damages. The two most sought damages in these cases are lost profits and lost business value.

We are proud to share that John Alfonsi, one of Cendrowski’s most knowledgeable resources in business valuation and economic damages calculations, has been featured in the GGI Newsletter. The publication highlights John’s invaluable insights and contributions to the field, as well as his track record of guiding numerous clients and legal teams through complex financial disputes to successful outcomes. In this article, we will delve into John’s analysis of the nuances between lost profits and lost business value regarding economic damages. Click Here to read the article.

Lost Profits vs. Lost Value: Two Main Types of Economic Damages

There are two main types of economic damages: lost profits and lost business value. Lost profits are the difference between the plaintiff’s actual profits and the profits they would have earned had the defendant not taken wrongful action. Lost business value, on the other hand, is the difference between the value of the plaintiff’s business immediately before and after the defendant’s actions. Damage experts must consider all the facts in determining which measure of economic damages is most appropriate. They must also ensure that their economic damages calculations do not overlap to avoid duplicate recovery of the same loss.

How are economic damages calculated in lost profits versus lost business value?

Both lost profits and business value are generally measured by the discounted value of lost income. Lost profits are calculated using incremental pre-tax cash flow, while lost business value is calculated using net after-tax cash flow. Both need to consider an appropriate discount rate and expenses – incremental expenses in lost profits and all applicable expenses in loss of business value. The threshold question is whether the lost cash flow is for a finite period (lost profits) or permanent/indefinite (lost business value).

For example, suppose a plaintiff entered into a five-year contract to provide parts. After year two, the defendant terminated the contract, constituting a breach. Economic damages would be measured by the lost profits for the remaining three-year term of the contract. Alternatively, if the defendant’s actions resulted in a permanent loss of all or a portion of the business (e.g., destruction by fire, elimination of a division), economic damages would be more appropriately measured by the loss in value of the business.

Avoiding Overlapping Damages and Considering Subsequent Events

Economic damages experts must ensure that their calculations do not overlap to avoid duplicate recovery of the same loss.

Where the breach resulting in lost profits results in consequential damages such as cessation of the business, damages analysis may include both lost profits and lost business value. Damages would be calculated using lost profits for the initial term and lost business value as of the date the damages become permanent. The damages expert needs to be careful, however, not to overlap the periods covered under each scenario of damages.

Another difference in these calculations is the application of subsequent events. In valuations, only information known or knowable as of the valuation date is considered. Subsequent events, if not known or knowable, are ignored. In lost profits calculations, however, subsequent events are routinely considered in determining damages.

Conclusion: The Importance of Expert Analysis in Economic Damages Calculation

In summary, economic damages experts need to carefully analyze the facts of the case to determine the most appropriate measure of damages – lost profits or lost business value. If you need help navigating complex financial disputes and determining the right approach to economic damages calculations, contact Cendrowski’s team of consultants. They can help you ensure that your calculations are accurate and avoid duplicate recovery of the same loss.

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