How We Calculate Economic Damages

A defensible economic damages analysis is built from the facts and the financial records up, not from a target figure down -- using a defensible "but for" scenario, testing assumptions like the discount rate, and pressure-testing the report before opposing counsel does.

Ask ten people outside this field how damages get calculated, and most will describe something that sounds like a single formula: figure out what was lost, multiply by some number, done. In practice, it's built the opposite way -- from the facts and the financial records up, not from a target number down.

Start with the damages story, not the method

The first thing I look at isn't which methodology to apply. It's what actually happened and what financial harm we're trying to measure. I don't start with a methodology and try to make the facts fit it.

If someone breached an agreement, I go straight to the contract: What was each party supposed to receive or pay, and what actually happened? If the allegation is lost profits, I'm building the "but for" world -- but for this event, what would the business reasonably have earned? That means digging into historical performance, revenues, expenses, trends, and the assumptions behind the projection. Business interruption is a little different because I'm looking at a specific disruption to operations and the financial impact tied to that interruption.

So the first question is really: what is the damages story the financial records need to tell? Then I determine the most appropriate methodology -- not the other way around. I'm not a fan of deciding we want a $10 million number and working backward from there. That tends to make for a very uncomfortable deposition.

A real file: the $13 million MOU

One matter that stands out involved a minority business owner who was essentially pushed out of the company. The parties had an MOU governing his departure, including the financial obligations tied to it. Things went according to the agreement -- until they didn't. That's usually when I get the phone call.

I broke the MOU down provision by provision and followed the money for each piece: what was actually paid, what should have been paid, the historical financial performance of the business, distributions and other relevant financial activity, and the support behind any assumptions used to calculate lost profits or other damages.

With lost profits, the key is that you're not pulling a hypothetical number out of thin air. You need a defensible "but for" scenario -- what likely would have happened financially if the disputed conduct had not occurred -- compared against what actually happened, accounting for the relevant expenses and other factors that could affect the calculation.

When I put all of the MOU components together, the total economic damages came to over $13 million. That's the part people tend to remember. But the more important part was that I could take that $13 million apart, explain it line by line, and show where the numbers came from. A big damages number is great. A big damages number you can actually defend is much better. (We've written up the litigation support side of a related $13.35 million judgment in more detail, if you want to see how it played out in court.)

The mistake clients make before calling a forensic accountant

The biggest mistake I see is starting with the damages number someone wants and then trying to make the financials support it. A client might say, "We lost $5 million," but when I ask where that number came from, sometimes it's lost revenue, sometimes it's a projection, and sometimes, frankly, it's just a really enthusiastic number.

Revenue and damages are not automatically the same thing. We have to look at the actual financial history, expenses, margins, trends, the period of loss, and what would reasonably have happened but for the event -- and make sure we're not double-counting damages across different categories.

The earlier I'm brought in, the easier it is to build that analysis from the records up rather than reverse-engineering a number someone has already fallen in love with. Because once a client becomes emotionally attached to a damages number, breaking up with it can be difficult.

Present value and the fight over the discount rate

When future losses get converted to present value, the assumption people argue about most is the discount rate. Everyone understands the basic concept that a dollar five years from now isn't the same as a dollar today. Where the arguments start is deciding what rate appropriately reflects both the time value of money and the uncertainty associated with those future profits.

That assumption matters -- a change in the discount rate can have a significant impact on the final damages number. So I'm not just plugging a percentage into Excel because it looks reasonable. I need to understand the business, its historical performance, the projected losses, the risks around achieving those projections, and the facts of the case, and then be able to explain why the rate I selected makes sense. Because "Excel told me so" tends not to hold up particularly well in a deposition.

When the "obvious" number turns out to be wrong

I had a breach of contract case where the plaintiff believed they were owed a significant amount in unpaid commissions. On the surface, the claim sounded straightforward: commissions weren't paid, so here's the amount owed. But once I got into the records, the numbers simply didn't support the damages amount being claimed.

I reconstructed the commission activity and compared what the plaintiff believed they were entitled to against what the underlying financial records actually showed. In doing that work, I also identified an accounting error on the company's books. That error didn't suddenly make the plaintiff's original damages calculation correct, but it did create an issue for the company that became important in resolving the case. The matter ultimately settled for considerably less than what the plaintiff had originally sought -- but still for a meaningful amount.

I like that example because it shows why you bring in a forensic accountant. My job isn't to prove the number my client wants. My job is to figure out what the records support, including the things they may not necessarily want me to find. Sometimes the million-dollar damages claim isn't there. Sometimes there's a completely different issue hiding in the books. And sometimes finding that issue is what gets everybody to the settlement table.

What a damages report needs to survive cross-examination

The weaknesses. A good damages report shouldn't pretend every assumption is carved in stone. If my calculation relies on a particular growth rate, damages period, margin, or other assumption, I want to know what happens if someone challenges it -- unsupported or incorrect assumptions can undermine the credibility of the resulting calculation.

That's why I pressure-test my own work before opposing counsel gets the opportunity. If changing one assumption sends my damages number off a cliff, I want to know that before I'm under oath explaining it. A defensible report isn't one that says, "Trust me, this is the number." It's one that shows you where the number came from, what it depends on, and why those choices are reasonable.

Key Takeaways

• Start with what actually happened and what financial harm needs measuring, then pick the methodology -- not the other way around.
• A defensible lost-profits calculation rests on a documented "but for" scenario, not a hypothetical number.
• The discount rate used to convert future losses to present value is one of the most contested assumptions in a damages report.
• Even an "obvious" damages claim can fall apart under forensic review -- and sometimes a different issue entirely surfaces.
• A damages report should show its own weaknesses before opposing counsel finds them.

If you're building a damages claim -- or need to pressure-test one someone else built -- contact us and we can help you get to a number that holds up.