When business operations are disrupted — whether by a broken contract, a supply chain failure, or an unforeseen event like a fire — companies often look to the courts for relief. One of the most common remedies in commercial litigation is a lost profits claim, which seeks compensation for the earnings the business would have made ‘but for’ the damaging event.

But proving lost profits is a complex and often contentious process. It requires credible evidence, clear causation, and expert financial analysis. This article breaks down the essential concepts and strategies that attorneys, accountants, and financial professionals need to understand when preparing or defending such claims.

What Exactly Are Lost Profits?

Lost profits are the net earnings a business would have realized if not for the actions — or inaction — of another party. As Ben Thomas, CPA and Senior Director at Alvarez & Marsal, explains, you can’t just count lost sales. The proper measure is lost revenue minus the costs saved by not having to fulfill those sales. In other words, economic loss is based on profits, not gross sales.

Variable costs, like raw materials and hourly wages, are typically deducted. Fixed costs, such as rent or insurance, usually remain unchanged and are not part of the lost profits equation. As Thomas notes, lost profits simply reflect the income the company would have gained after subtracting costs it avoided because of the disruption.

Three Legal Hurdles Every Plaintiff Must Clear

It is important to understand the legal framework for a lost profits claim. Plaintiffs need to demonstrate:

1. Causation – A direct link between the defendant’s wrongful conduct and the business’s financial loss.
2. Foreseeability – The loss must be one that the defendant could reasonably have anticipated when entering into the business relationship.
3. Reasonable Certainty – The plaintiff must support their claim with a solid evidentiary foundation. Courts won’t award damages based on speculation.

Matt Blumenstein of Statera Capital cautions that lost profits are often challenged for being too speculative. The more attenuated or aspirational the claim, the less likely it will stand up in court.

Picking the Right Method: Four Common Approaches

There’s no one-size-fits-all formula for calculating lost profits. The right approach depends on the available data, the industry context, and the business’s history.

Here are four commonly accepted methods:

1. Before-and-After

This compares business performance before and after the disruptive event. If there’s a sudden decline post-event, and no other plausible explanation, the difference may be recoverable.

2. Yardstick

Here, the business is compared to a similar company or industry benchmark unaffected by the harmful act. This can be especially useful for new businesses that lack a long track record.

3. Sales Projection

This approach relies on the company’s own financial forecasts — ideally created in the ordinary course of business before the dispute arose.

4. Market Share

This method uses the company’s historical market share to estimate its expected revenue during the damage period. It’s often applied when robust industry data is available.

Megan Becwar, Principal at Dispute Economics, notes that a key challenge is data availability. Ideally, multiple methods would be used to triangulate a reliable result, but realistically, companies often have to go with the best available evidence and adapt accordingly.

The ‘But For’ World: Why Counterfactuals Matter

A cornerstone of any lost profits analysis is the ‘but for’ scenario — an estimate of what the business would have earned had the harmful event not occurred. This involves a comparison between the actual outcome and the projected financial outcome under normal conditions.

As John Levitske, Partner at HKA Global, explains, the company needs to provide a credible explanation for the projected outcome. This can include past financials, signed contracts, and industry trends. A flawed or unrealistic projection can seriously undermine the claim.

What If the Business Is New?

Historically, new businesses have had a tough time claiming lost profits because they lacked performance history. In the past, courts have often deemed such claims too speculative.

But that’s changing. Thomas explained that modern courts now allow new businesses to pursue lost profits if they meet the reasonable certainty standard. That often means relying on:

• Industry benchmarks
• Startup contracts
• Founders’ track records
• Market data

Recent cases — such as Williamson Co. v. Ill-Eagle Enterprises — show that courts may allow discovery and even recovery where a startup can document its path to profitability.

The Crucial Role of Experts

A qualified expert witness is almost always necessary in these cases. They help:

• Select the appropriate methodology
• Build a damages model
• Interpret and analyze financial data
• Testify credibly in court

As Becwar highlights, credentials matter. Someone with training in both valuation and litigation is ideal because they will understand the standards and know how to explain them in a courtroom.

Useful certifications include:

• CPA (Certified Public Accountant)
• ABV (Accredited in Business Valuation)
• ASA (Accredited Senior Appraiser)
• CFA (Chartered Financial Analyst)

Don’t Forget Mitigation and Incremental Costs

A plaintiff also has a duty to mitigate damages. That means taking reasonable steps to reduce losses. For example, if a manufacturing facility is shut down, the company should try to lease a temporary space or source parts elsewhere — even if that’s more expensive.

Megan Becwar pointed out that such efforts can be recoverable. Costs incurred to mitigate damages — such as renting an alternate facility — can be added to the claim, so long as they’re well documented and directly related to the harm.

Just as important is accurately calculating incremental costs — those expenses that would have been incurred had the business continued operating. These typically include:

• Raw materials
• Sales commissions
• Hourly wages

Costs that don’t change with production — like office rent or corporate overhead — usually won’t count.

Common Defense Strategies

If you’re on the defense side, there are several ways to poke holes in a lost profits claim:

• Speculation – Challenge the reliability of projections or business plans.
• Causation – Argue that external factors (e.g., COVID-19, economic downturn) contributed to the losses.
• Overreach – Highlight ‘hockey stick’ forecasts that show unrealistic growth.
• Limitations in the Contract – Point to contractual language that disclaims consequential or indirect damages — including lost profits.

Blumenstein emphasizes the importance of a reasonable claim, pointing out that if a company’s claim looks like a windfall, it risks losing credibility with the jury.

Final Thoughts

Lost profits claims sit at the intersection of law, finance, and common sense. Whether you’re asserting or defending such a claim, success depends on your ability to prove the numbers, tell a persuasive story, and anticipate the scrutiny of opposing counsel.

• For plaintiffs, that means careful preparation, sober projections, and expert support.
• For defendants, it means knowing where to look for weak assumptions, outside influences, or contractual protections.

With the right team and the right tools, lost profits cases are winnable—but they’re rarely easy.

To learn more about this topic view Nuts & Bolts of Lost Profit Cases. The quoted remarks referenced in this article were made either during this webinar or shortly thereafter during post-webinar interviews with the panelists. Readers may also be interested to read other articles about litigation. 

This article was originally published here.

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