Lost profits are generally calculated before the deduction on income taxes because lost profits awards are taxable upon recovery. Conversely, lost business value occurs when a business never commences operations, ceases all or part of its operations, or permanently loses a segment of its business.
Lost profits v. Lost business value
In commercial litigation, the primary role of a financial expert is to compute economic damages that may have been suffered by a party.
In order to quantify economic damages, experts are commonly asked to calculate lost profits and/or lost business value. As a result, they must determine which approach is most appropriate to use.
A fundamental difference between lost profits and lost value is the expected duration of the loss. Loss profits are a measure of damages typically utilized when a business or segment of business continues to operate but suffers reduced income for a finite period’ and measurement is calculated for a period until the business regains the position it would have been in had the alleged damaging act not occurred.
Lost profits represent the incremental change in revenue attributable to a particular action, plus or minus the change in expenses arising from the change in revenue attributable to a particular action. Lost value relies on net cash flow, after the deduction of all expenses. It is a measurement of a return to an investor using net after-tax cash flows that are discounted to a present value.
There are three generally accepted approaches utilized to determine lost business value. The asset-based approach involves calculating the net equity of the business. Depending on the income method chosen, the value is derived by applying a capitalization rate or a discount rate to the expected future earnings to arrive at a present value of the future benefit stream. The market approach pricing multiplies obtained from sales transactions and applies them to the appropriate performance measure of the company being valued.
These approaches are performed before and after the date of harm and the difference is considered the lost business value.
Depending on the facts and circumstances of litigation, either lost profits or lost business value approaches can be utilized-but not simultaneously. Whichever approach is used, the financial expert should ensure that the methodology and related processes are described fully and correlate to the cause of damage.
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