Calculating the Cost of a Shutdown

COVID-19 has caused business profits across a wide range of industries to slow down, and some to stop entirely.  Business such as gyms and fitness centers have had to close their doors for an extended period of time, while others have pivoted the services provided or experienced temporary closures or changes.  Businesses were “interrupted” due to the pandemic.  Many business owners are wondering if they are able to be compensated for this interruption.

While business interruption insurance policies can be commonplace, it is not always clear how a shutdown due to a pandemic is covered.  The business interruption insurance claims related to COVID-19 will be a significant issue for years to come.

In order to quantify the magnitude of financial loss or damages arising from the pandemic, an expert is often employed and can be involved on both the insured and insurer side of a claim.  Losses are calculated using a “but for” approach, which means that the expert assesses what the business would have earned “but for” a certain triggering event.  So, lost profits are calculated as the difference between what would have been earned in a non-pandemic world, and what was actually earned over a period of time.  This concept can be most easily grasped using the graph below:

Business Loss Interruption

Let’s look at a simple example of a financial loss calculation:

Business Interruption Period:  3 months

Expected Profits during Interruption Period:  $1 million

Actual Profits during Interruption Period:  $300,000

Business Interruption Loss:  $700,000

The losses, if happening over an extended period of time, would likely be discounted to a present value number based on the principles of Time Value of Money and the business risk of the company filing the claim.

There are a number of factors that can impact the numbers above.  The business needs to be able to support the expected profits based on financial analysis including review of historical financial and operating data and projections/forecasts that were prepared prior to the triggering event.  There are also other challenges in supporting these calculations involving the determination of when the business is truly restored to normal operations when recovering from an interruption, as interruptions can take the form of complete business suspension or simply a reduction in business.

Business interruption claims are among the most complex, and controversial types of insurance coverage.  A lot of this is due to the fact that insurance companies have to reimburse companies for what could have happened, not what did actually happen.  Companies have to be in a place to have solid proof that they would have made a certain amount of revenue, had COVID-19 not taken place.

CPAs who have expertise in helping companies value their business, and clearly identify and communicate revenue they would have received to their insurance provider, are going to be highly sought after now, and most likely 10 to 20 years from now.  We predict insurance claims from COVID-19 will last for at least another twenty years.

We have deep expertise not only valuing businesses, but working with them to file business interruption claims.  Please don’t hesitate to reach out to us if we can provide guidance to your organization, during this unprecedented time.  We are available, and we are here to help.