Calculating Economic Damages & Lost Profits: Key Insights

Thomas Pastore, ASA, CFA, CMA, MBA | CEO & Founder | Sanli Pastore & Hill, Inc.

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.

Author Bio

Thomas Pastore, ASA, CFA, CMA, MBA

CEO & Co-Founder of Sanli Pastore & Hill, Inc.

Mr. Pastore is CEO and Co-Founder of Sanli Pastore & Hill, Inc. He has been involved in financial consulting for over 35 years, specializing in litigation consulting M&As (fairness opinions, projections, scenarios and stress testing), intellectual property and intangible asset valuations, and public accounting. Mr. Pastore has served as an expert witness in federal and state courts for business litigation cases in California, Texas, Arizona, Wisconsin, Nebraska, North Dakota, and New York. He has testified in 70 trials and over 200 depositions.

Company Overview

Sanli Pastore & Hill, Inc. (SP&H) is a firm specializing in business, brand and IP valuations, fairness and solvency opinions, transaction advisory services, and expert testimony and litigation opinions, forensic accounting, finance and economics, with offices in Los Angeles, Sacramento, San Diego, Chicago, Lagos, Brussels, and Paris. SP&H’s principals and senior professionals have over 200 years’ combined experience utilizing their intuition and perspective to create confidence in the results. Our partners have been named as expert witnesses in over 1,200 court proceedings and have provided over 4,000 financial opinions and testimony for shareholder disputes, marital dissolution, intellectual property litigation, mergers and acquisitions, fairness and solvency situations and other advisory services. Each year, SP&H works on over 150 matters, which include forensic accounting and litigation support matters, valuations of business brands, patents and intellectual property for businesses ranging from start-ups to Fortune 500 companies, Forbes 400 members, U.S. government agencies, and foreign governments. The industries we cover include technology, entertainment and media, medical and life sciences, consumer products, manufacturing, telecommunications, software, energy, defense and service. The firm has unequaled research and analytical capabilities, as well as the dedication, creativity and excellence of its staff, which ensure superior quality products and results.

[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.