The Pandemic Effect: Business Interruption

During WFH, Business Owners should begin building their Document House for Business Interruption Claims

All business owners have been faced with a myriad of decisions of late: to stay open or not to stay open; how to work remotely; what operating expenses can be reduced during this time period; will employees be furloughed or laid off; navigating the PPP loan application process; and the list goes on and on…. An additional item that business owners should begin to think about, if they haven’t already, is lining up their documentation and associated loss calculations for purposes of filing a Business Interruption claim.

Claim Documentation:

Much remains to be seen with Business Interruption coverage as the COVID-19 pandemic plays out and there continues to be insurance litigation cases filed as well as various regulatory responses. However, if and when it is determined that coverage is granted as a result of the uniqueness of the current economic impact, business owners should not be caught without their “document house” in order.  Below is a general overview of the types of documents often required by insurance carriers in support of a business interruption claim:

  • Monthly profit and loss statements
  • Tax returns
  • Budgets or forecasts
  • Monthly or weekly sales reports
  • Monthly or bi-monthly payroll reports
  • Bank and credit card statements
  • Invoices / expense documentation
  • Monthly or weekly inventory reports and documentation
  • General ledger
  • Lease / rental agreements

Loss Calculation:

In addition to the underlying documents provided as support, insurance carriers will be looking for well thought out and sound loss calculations.  From a calculation standpoint, there are two ways to calculate a loss and both involve the “but for” scenario had the event in question not occurred:

  • Lost gross sales, minus non-continuing expenses (“top-down” approach); or
  • Lost net income, plus continuing operating expenses (“bottom-up” approach).

Either calculation methodology can be used because when performed properly, they result in the same conclusion and thereby serve as a “check” on one another.  Irrespective of the method chosen, developing a sound basis for the lost sales or lost net income during the claimed period requires not only a thorough understanding of the business operations during “normal” economic circumstances, but also on a go-forward basis after operations begin to return to pre-loss levels.  Such consideration is important particularly in industries where revenue may not actually be lost per se but rather delayed and recognized at a later date.

Business owners also have a duty to mitigate their losses during the claimed period, and such mitigating sales (if any) serve to offset the loss. From a review standpoint, documenting mitigation efforts is extremely important, even if there are no mitigating sales to offset the loss. Since the insured has a duty to mitigate, the insurance carrier will expect to understand what effort was made even if those efforts were not ultimately fruitful.

A thorough understanding of a company’s expense structure is equally important when identifying non-continuing (typically variable and semi-variable) and continuing (typically fixed and semi-fixed) costs.  Overestimating non-continuing expenses, or underestimating continuing expenses will result in an understated loss calculation; while the reverse estimation will result in an overstated loss calculation.

In addition to Business Interruption coverage, some policies may also provide for “extra expense” coverage. It will be important for business owners to separately identify any extra expenses outside of those which are normal continuing expenses and in doing so provide strong support as to why those expenses are extraordinary in nature.

As forensic accountants and valuation experts, we understand what makes businesses “tick.”  We are uniquely positioned to assist our clients in preparing Business Interruption claim calculations which will ultimately withstand a high level of scrutiny, including litigation if a matter were to proceed that far.  Please reach out to schedule a conversation with one of our experts today if we may be of assistance.  In the meantime, take care, stay healthy, and document, document, document!

If you’re looking for more information on business valuations or just need some advice, contact us today.

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Joshua Vannetti, CPA, CVA is a Director at Vantage Point Advisors and provides services in the areas of business valuation, marital dissolution, bankruptcy, lost-profit analyses, and the quantification of economic damages. In addition, Mr. Vannetti conducts business valuation work for financial reporting and tax compliance purposes.