Key considerations of business interruption loss quantification

10 March 2022 / Insight posted in Article

A business interruption event can have a significant financial impact on a company and as such it can be a difficult experience for a business owner or senior management team. From the point of view of the business a pay-out based on the losses sustained should be fair and just compensation. However, in the world of litigation this virtuous occurrence is not as commonplace as it should be, often due to a poorly prepared business interruption loss quantum calculation easily picked apart by the opposing party.

In this article, I intend to highlight those key quantification aspects of a claim that if properly addressed by the business, or more likely, accountant acting on its behalf, will go a long way in helping to achieve that all too elusive fair and just pay-out.

 

Understanding the claimant’s business

In simple terms the role of the accountant in any type of business interruption claim is to quantify the losses that have been sustained, in effect attempting to put the claimant back into the position they would have been, in monetary terms, had it not been for the business interruption event. This will involve gaining a detailed understanding of the claimant entity in terms of its operations and financial performance/position, but also importantly fully understanding how the event has impacted the business.

This is a crucial first step as this will set the foundation for any subsequent loss modelling. If the accountant does not fully grasp the impact on the business, then he or she will not be able to properly tailor the loss model, and consequently, quantified losses may be under- or overstated. This stage takes time and effort and will constitute a series of meetings/conversations with the business owner or key personnel, being the ones who truly understand the business and who have lived through the business interruption.

 

Isolating the loss

It is crucial that the loss calculation isolates those losses sustained by the business as a direct result of the business interruption.  It is often the first argument of the defence that the losses claimed were caused by factors other than the business interruption event.

So, for example, has the business interruption calculation allowed for any expected variation in the seasonality of the business? It may be that, for example, the business interruption event occurred just at the point when sales tend to drop following Christmas trading. In this situation it would be overstating the claim if the calculated loss in sales is not adjusted for the expected drop at this point in the year. There may also have been external market conditions that would have affected the business absent the interruption event, such as decreases in the price of the product being sold or increases in the cost of raw materials, which will need to be factored in.

 

Establishing the loss period

The loss period itself is often highly material to the loss calculation, and therefore being able to establish this with a high degree of certainty is of real benefit to the business interruption quantum calculation. In broad terms the key consideration here is establishing the period from which the business was first impacted by the business interruption event, to the point when the business had fully recovered, which typically equates to the point when its profits returned to normalised levels.

An assessment of when the business has recovered from a retrospective standpoint is often relatively easy, as it will be a case of looking at the monthly profits to identify the point of return to normalised levels. This is more difficult when an assessment is required at a point when the business has not yet recovered, and therefore the assessment becomes a calculated estimate based on the facts of the claim.

A recent business interruption case of mine involved the delayed opening of a care home. A key issue was establishing the period of loss, which was driven by projecting the point when the delayed care home would reach maturity. Predicting this period was not a straightforward task and involved using the profit profile of another care home in the claimant company group as a comparator, which had recently opened and so the period of trading up to maturity could be used as a proxy for the claimant care home.

 

Quality of financial information

Financial information on the affected business which is insufficient or of a poor quality can diminish the success of the claim because this information is usually the foundation of the loss calculation.

It can sometimes be the case that the claimant is adamant there has been a loss, but is unable to produce financial information of a sufficient quality to demonstrate this. In this situation the key question that comes from the defence is “where is your evidence to prove this?”. The burden of proof is on the claimant, and it is a fact of litigation that a court or tribunal will place great weight on supportable factual evidence; claims unsupported by reliable and convincing evidence are often doomed to failure.

There tends to be a real spectrum in terms of quality of financial information that can used in a business interruption quantum calculation. This ranges from detailed monthly management accounts that can be reconciled to the filed financial statements, and which includes an analysis of all income and costs by service line and product, to nothing more than filed abbreviated year end accounts. In this situation one may be faced with having to retrospectively generate detailed accounts from historic accounting data, which can be a time consuming and costly exercise.  This will also be seen as being performed after the business interruption event which will always be viewed unfavourably by the insurers, and ultimately the court or tribunal.

 

Final word

The art of any business interruption loss quantification is to demonstrate that the losses have been suffered in a way that is understandable, logical, supportable, and clearly evidenced. Where possible, a claimant should put forward a robust case underpinned by a business interruption loss calculation based on these key principles emanating from those considerations above. By doing so, there is every likelihood that they will succeed in receiving a fair and just pay-out.

For more information, please contact a member of the forensic accounting team.