It is not uncommon that when we first get involved with a business interruption claim, the client will already have created an initial estimate of their losses. We will often hear things like:
“I’ve lost a million dollars in revenue”
“We’ve had canceled sales of $300,000”
Many times, these initial loss estimates are not accurate, simply because the insured does not have a proper understanding of the insurance policy coverage. One of the most common misconceptions about business interruption insurance is that in the event of a loss, a policyholder will be able to recover their lost sales or revenues. In reality, the coverage typically affords recovery of an amount that more closely resembles a business’ cash flow. The analysis required by the insurance policy requires calculating not only the lost revenue, but just as importantly, also considering what expenses have been saved as a result of the interruption. Take a restaurant for example, such “savings” could include the acquisition cost of food and beverages because the restaurant is not serving customers meals and drinks. Or consider a hotel that suffers a loss, reducing the number of available rooms – the hotel could save costs related to room and cleaning supplies, given that no guests are in those affected rooms. These are just two examples of non-continuing, or discontinuing expense; that is, expenses that the business would incur during the normal course of business. This is an important concept sometimes lost on policyholders, because the overall goal of business interruption insurance coverage is to put the business in the same financial position it would have been in “but for” the loss. This means no better or no worse.
While there are many ways to analyze and determine a business’ non-continuing expenses during an interruption period, one quick way to estimate these expenses would be to review its rate of gross profit. Essentially, the Insured should be able to recover their true gross profit which, as happens normally, would allow them to recover all of their additional operating expenses. Anything left over as a net profit (or loss) would also flow back to the business. This aligns with the standard definition for business income which is defined as the net profit (or loss) plus the continuing expenses.
By: Chris Mortifoglio, Senior Vice President and Director of Forensic Accounting | Procor Solutions