Calculating Economic Damages & Lost Profits – The Science Behind The Numbers

[author: Thomas Pastore]*

In the complex world of civil litigation involving claims of lost business value or lost profits, accurately calculating economic damages is a critical part of successful outcomes. This article explores the multifaceted approach to quantifying economic harm, breaking down the process into key areas of analysis.

Revenue and Sales Analysis

The foundation of any damages calculation begins with a thorough examination of revenue and sales. This top-down approach involves:

• Estimating "but-for"[1] revenues and comparing them to actual figures

• Analyzing market share changes before and after the damaging event

• Adjusting for seasonal fluctuations and expected growth rates

• Assessing market penetration capabilities

• Utilizing comparable sales data from similar businesses

Cost Analysis

Understanding the cost structure is crucial for accurate profit calculations:

• Identifying avoided costs associated with lost sales

• Analyzing incremental costs that would have been incurred

• Distinguishing between fixed and variable costs

• Evaluating extraordinary expenses resulting from the defendant's actions

• Considering customer retention, regulatory compliance, and financing costs

Operational and Capacity Considerations

Operational factors play a significant role in determining the feasibility of claimed losses:

• Assessing production capacity for claimed lost sales

• Evaluating supply chain disruptions and their financial impact

• Analyzing economies of scale effects on per-unit costs

• Examining working capital changes

• Considering the product life cycle impact

Market and Economic Factors

External forces must be accounted for in any comprehensive analysis:

• Evaluating industry-specific trends and broader economic conditions

• Assessing competitive responses during the damage period

• Considering currency fluctuations for international businesses

• Factoring in regulatory changes affecting profitability

Financial and Valuation Techniques

Applying appropriate financial methodologies supports robust calculations:

• Discounting future losses to present value

• Valuing a business’ assets and equity before and after the alleged harm

• Employing statistical forecasting and regression analysis

• Applying a legally accepted rate of return to past losses to determine their present value

Damage Period Considerations

The damage period must be carefully assessed:

• Determining the appropriate loss period

• Assessing mitigation efforts and contributory negligence

Intangible and Long-term Impacts

Lastly, it is crucial to consider less tangible, but often substantial, long-term effects:

• Quantifying reputational damage and brand value impact

• Evaluating technological obsolescence risks

• Analyzing customer lifetime value and long-term relationship impacts

Conclusion

By systematically addressing these key areas, financial experts can provide a comprehensive and well-supported analysis of economic damages. This methodical approach provides robust and defensible damages calculations in litigation and dispute resolution contexts.

[1] In the context of lost profits analysis, the "but-for" framework is typically used to determine the financial impact of an event or action by comparing actual financial outcomes to a hypothetical scenario where the event or action did not occur.

*ASA, CFA, MBA - IR Global , Firm - Sanli Pastore & Hill