Navigating ‘battleground issues’ around lost profits

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When examining lost profits, there are several “battleground areas” to take into consideration. And when financial experts have to get involved in legal cases, there are several ways to help them generate their report for the case.

Zach Reichenbach, a principal in Ellin & Tucker’s Forensic and Valuation Services group, explained these issues during a webinar last week sponsored by Ellin & Tucker and hosted by The Daily Record.

“In a lot of these cases it comes down to two or three issues at play,” Reichenbach said. “The expert who typically succeeds is the one who has the more supportive and fact-based opinion and analysis.”

Here’s a look at some of the different issues Reichenbach says often develop in these types of cases – and how attorneys can help the financial experts in generating their report.

Damage period

Typically, it is easy to determine the date the damages started, either via a breach of contract or some other infringement. Sometimes, in slander or defamation cases, the time frame can be harder to determine, but the start date usually isn’t disputed.

The harder issue is determining the end of the damage period. In a breach of contract, the period may end with the contract, but if there is no contract, it may depend when a company returns to its operating level prior to the incident.

Historical vs. future

Lost profits can be both historical and future. The trial date determines which category the lost profits fall into.

There are two scenarios Reichenbach said his team explores for determining lost profits. The “but-for” scenario considers what the company would have done but for the damage or incident. The “actual” scenario considers what actually happened during the specified time period.

The actual scenario can often be based on financial statements provided by the company. That can become complicated in the future projections as experts are predicting what a company will do moving forward.

Lost profits, not sales

Lost profits are not equal to lost sales a company thinks were impacted by the damages. Fixed costs, like a company’s rent, are not included in the calculation.

“We only consider the variable costs that are associated with this, we don’t consider any of the fixed costs,” Reichenbach said. “We know that variable costs will fluctuate with revenue.”

Revenue projections

Questions around revenue projections often becomes a battleground issue. Since the projections are subjective, it often comes down to the experts’ information and methods used to reach those projections.

The more information available to the expert the better, Reichenbach said, but it also depends what type and when that information is from. It may also depend on the market or industry data an expert uses too.

Reichenbach said it’s best if he has financial information from before the damaging event occurred, and it helps if a company has a good track record of making good historical projections. While projections after the damaging event can still be helpful, they must be reviewed carefully to determine how useful they are.

Consulting or speaking with a company’s financial officers is ideal but if not, reviewing historical growth rates and market data can help.

In the end, revenue projections can vary widely. Some can be aggressive in showing how a company would perform while others are more conservative. Reichenbach said he tends to lean toward the conservative as he can support it better.

Variable vs. fixed costs

Determining if a cost is variable or fixed can often be a time-consuming exercise. Reichenbach said this is where speaking with financial officials at a company can crucial. Experts can also use their own experience and look at common-sized analysis as well as market data or an industry expert.

When comparing market or industry data, it’s important to look at comparable information. Reichenbach pointed to a case involving a medical device where an expert had used data looking at food and plants industries that was not comparable.

Helping out

Reichenbach said an attorney’s ability to provide access to as much information is possible is key. Reviewing documents is the best way for the financial experts to determine what is relevant and what isn’t.