Lost Profits and But-For Analysis

By Christopher Skerritt, M.Ed., MBA, Chief of Economic Services · Published

Lost profits measure the difference between the profits a business would have earned had the wrongful act not occurred and the profits it actually earned or will earn. The economist builds the but-for scenario from the company's own history, its market, and the terms of the disrupted relationship, subtracts actual results and avoided costs, and reduces future losses to present value.

When it is used

Lost profits are the usual measure in contract disputes, business interruption claims, and cases in which a business was harmed but continues to operate. Where the business was destroyed, the measure may shift to lost business value, as the lost profits versus lost business value guide explains. The lost profits service covers both.

Step-by-step

  1. Define the loss period from the date of the wrongful act to the date the business recovered, or would have recovered, or to the end of the disrupted relationship
  2. Establish but-for revenue using a before-and-after comparison, a yardstick comparison to similar businesses or markets unaffected by the act, or the projections the parties themselves relied on before the dispute
  3. Deduct the costs the business avoided by not earning the lost revenue, so that the loss is measured in profits rather than sales, and distinguish fixed costs from variable costs
  4. Account for mitigation: what the business did or reasonably could have done to replace the lost business, and any profits it earned as a result
  5. Test causation for each component of the loss against other events in the period, such as market changes, competition, or management decisions, and exclude losses with other causes
  6. Reduce future lost profits to present value at a rate that reflects the risk of the projected profits, and state the basis for the rate

Data sources

Limitations

Lost profits for a new or unestablished business rest on projections without a track record and face a higher bar of proof; the report must show the basis for each projection. The but-for scenario is a counterfactual, and a projection that ignores the ordinary risks the business faced overstates the loss. Fixed and variable cost classification drives the result and should be documented from the company's own accounting rather than assumed.

Admissibility

Lost profits methodology using before-and-after and yardstick approaches is well established in commercial litigation. Reports are excluded when the projection has no foundation in the company's history or market, when avoided costs are not deducted, or when the expert assumes causation rather than analyzing it. Reasonable certainty is the standard most jurisdictions apply to the fact of loss, with more latitude on the amount once the fact is shown.

Frequently Asked Questions

What is the difference between lost revenue and lost profits?

Lost revenue is the sales the business did not make. Lost profits deduct the costs the business would have incurred to make those sales but avoided. Damages are measured in lost profits, which is why the cost analysis matters as much as the revenue projection.

How long can the loss period be?

As long as the effect of the wrongful act lasts, which may be the remaining term of a contract, the time needed to rebuild a customer base, or, where the business never recovers, an indefinite period that is usually better handled as lost business value. The report explains the basis for the period chosen.

Can a start-up recover lost profits?

In many jurisdictions, yes, if the projections rest on evidence such as signed contracts, comparable businesses, or the performance of the business before the event. The analysis is more demanding and the report addresses the risks the business faced directly.

Services that use this method

References

Request a consultation on Lost Profits and But-For Analysis or call (201) 343-0700. Plaintiff and defense counsel.