Read more about the current Greenbook proposals. ...
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In my last article, I discussed how to calculate lost revenue related to a fire in ABC Company’s manufacturing facility. In this article, I will complete the lost profits claim (as a reminder, lost profits are calculated simply as lost revenue less avoided costs) and discuss how to determine avoided costs.
Avoided costs are defined as the incremental costs that were not incurred because of the loss of the revenue. Unlike lost revenues, there are no specific methods that outline how to determine avoided costs. However, the starting point of an analysis of avoided costs is often the cost structure of the subject business, specifically, fixed versus variable costs. In general, if a cost is variable, it can be avoided (and thus should be deducted from lost revenue). If the cost is fixed, it cannot be avoided (and thus should not be deducted from lost revenue).
An analyst can estimate avoided costs using nonstatistical and statistical methods. Any analysis can be considered as long as it can be reasonably supported. While a review of all of the available (nonstatistical and statistical) methods is beyond the scope of this article, I will discuss one method within each category.
While the past two articles have looked at a lost profits (lost revenue and avoided costs) at a high level, the actual quantification of lost profits analysis requires detailed analysis and significant experience. Schneider Downs has prepared numerous lost profits analyses and reports that meet the needs of an insurance company or, in many cases, have been presented as evidence in court. If you have any questions on lost profits, please contact Schneider Downs and visit our Business Advisors webpage to learn about the other business advisory services that we offer.
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