Welcome back to Follow the Money. Over the past few months, we have walked through hidden transactions, inflated balance sheets, shareholder value suppression, and embezzlement schemes. This time, we are focusing on a topic that often sits at the center of commercial disputes—and usually generates the most debate between experts: calculating economic damages, especially lost profits.
In cases involving breaches of contract, business interruptions, unfair competition, IP infringement, or broken partnerships, lost profits frequently make up the largest portion of damages claimed. But even though these calculations are common, they are rarely straightforward. Reconstructing what should have happened financially requires professional judgment, supporting objective evidence, and a methodology that can stand up before a judge, mediator, or opposing expert.
Courts require lost profits to be proven with reasonable certainty, not guesswork. That is where forensic accountants come in—we bridge the gap between “what likely would have occurred” based on the financial records, grounding the numbers in historical performance, market data, and sound economics.
Why Lost Profits Matter in Commercial Disputes
Lost profits represent the income a business expected to earn if the disruption had not happened. They differ from out of pocket damages because they measure missed business opportunities caused by wrongful action, not direct expenses.
These claims arise in all kinds of situations, including:
- A supplier breach that forces a temporary shutdown
- Business interruption resulting from negligence or property damage
- A partnership ending abruptly during peak revenue periods
- Interference with contracts or customer relationships
- IP theft that diverts sales to a competitor
Because these losses can span months—or even years—they often become the centerpiece of litigation, with both sides presenting competing financial narratives.
The Main Approaches for Calculating Lost Profits
Forensic accountants select the method that best fits the data and circumstances. In practice, there are three widely recognized and accepted approaches:
- Before and After Method
This compares a company’s performance before the incident to what happened after.
It works best for established businesses with stable historical patterns.
Example: A company consistently growing revenue by 10–15% per year suddenly flatlines or declines after a breach. The difference between expected growth and actual performance—minus variable costs—forms the basis of lost profits. - Yardstick (Comparable) Method
The experts benchmark the injured business against similar companies, industry averages, or competitors unaffected by the event.
It is useful when pre incident data does not provide a reliable baseline—such as a start-up or those going through major transitions. - But For (Sales Projection) Method
This method builds a hypothetical “but for” scenario using forecasts, budgets, contracts, customer history, and market assumptions. It is more flexible and especially helpful when a business’ growth trajectory is changing or when historical data alone does not reflect the expected performance.
How Forensic Accountants Build the Analysis
A credible lost profits calculation usually follows a structured process:
- Define the Loss Period
This time frame could run until the business returns to normal operations or until a contract has ended. Courts scrutinize this area closely. Longer damage periods must be backed by credible evidence. - Establish the Baseline
We examine historical financials, tax returns, sales records, and operational data to understand performance trends before disruption. - Project But For Results
This approach includes revenue projections and an analysis of variable costs, ensuring we avoid overstating losses by incorrectly deducting unavoidable fixed expenses. - Evaluate Mitigation Efforts
Did the business take reasonable steps to reduce losses? If so, additional costs may be recoverable (rush orders, temporary hires, alternative sourcing). If not, expected profits may need adjustment. - Discount Future Losses
When future profits are involved, we discount them to present value using a relative risk adjusted discount rate. - Sensitivity Analysis
Running multiple scenarios (conservative, moderate, and optimistic) helps demonstrate that assumptions are well reasoned and not one sided.
The tools vary—Excel models, regression analysis, industry research, customer data, third party confirmations—but the goal is the same: prepare a well-reasoned calculation that withstands scrutiny.
Common Challenges and Attacks from Opposing Experts
Lost profits are heavily litigated, so it is no surprise that opposing experts often challenge:
- Projections that appear too optimistic
- Failure to consider mitigation
- Causation—whether the loss resulted from the alleged wrongful act
- Cost treatment (overstating losses by ignoring fixed cost realities)
Sound methodology, clear documentation, and realistic assumptions are the best defenses.
How Lost Profits Findings Influence Litigation
A well-supported analysis can shift the momentum of a case:
- It provides a framework for mediation or settlement discussions
- It strengthens claims for consequential damages
- It supports punitive damages if tied to intentional misconduct
- It helps courts evaluate whether the plaintiff’s claim met the “reasonable certainty” standard
- In federal courts, expert standards set forth by Daubert make forensic rigor essential—weak or speculative analyses usually do not survive.
Practical Takeaways for Litigators and Businesses
- Involve forensic experts early—it shapes discovery requests and avoids missing key documents.
- Obtain a complete set of financial records. Data gaps make lost profits harder (and more expensive) to prove.
- Write contracts with clear performance metrics, mitigation expectations, and agreed-upon remedies.
- Lost profits analysis is not guesswork, it’s a reconstruction of financial reality supported by documents, data, and analysis. When prepared thoroughly, it reveals the economic story behind a claim.
What challenges have you faced when calculating or disputing lost profits?
AUTHOR BIO:
Charles “CJ” Pulcine, CPA, CFF is a Manager in Smolin’s Forensic and Valuation Services practice, specializing in forensic accounting, fraud investigations, and litigation support. He is a licensed Certified Public Accountant in New Jersey and holds the Certified in Financial Forensics (CFF) credential.
With more than seven years of experience in forensic accounting, financial audits, and fraud investigation, CJ works with businesses and legal counsel on financial fraud investigations, commercial litigation support, matrimonial litigation, business valuation analyses, and shareholder disputes. His work focuses on uncovering hidden transactions, tracing assets, and analyzing financial misconduct.
As a member of Smolin’s forensic team, CJ supports attorneys throughout the litigation lifecycle, including asset tracing, damages analysis, and preparation of financial evidence for mediation, depositions, and trial. He practices out of Smolin’s Red Bank, New Jersey office.