October 2008

ASK THE EXPERT SUBMISSION – FORENSIC INSIGHT

Question

Is there an easier way of assessing or quantifying losses when they are too small to warrant engaging an accountant? Also, is there some basic information that should be requested that will provide a sound logical approach to the measurement of these types of losses?

Answer

Unfortunately there isn’t an easy way or ready-made solution that you can apply that will fit all situations. Some of these small losses can be quite challenging as you need to obtain the same kind of information that you would to assess a much larger loss. Since the dollars involved in these small losses do not warrant an extensive review you will likely obtain the necessary information through enquiry with a knowledgeable representative without obtaining supporting documentation (but that will be a judgment call depending upon what is at stake and the particular situation).

So...where to begin?

First you must obtain a complete understanding of the insured’s business and how the incident has impacted on the normal operations.

Where in the production process has the incident occurred and what impact did this have on finished goods (or saleable) production? Typically you will need to measure the impact on the finished production or the product that is sold by the insured and differentiate between losses that occur within any uninsured waiting periods.

Then you need to assess whether the lost production can be made up. Is the insured working at capacity, or does the insured have capacity to make up the lost production by working overtime, adding a shift or at another under-utilized facility? Can the lost production be outsourced to avoid the loss of sales? If the production loss can be made up, then typically the loss measurement is based on the incremental costs that were incurred over the normal costs that would have been expended. It is important to factor into your calculations any normal costs that are saved as a result of outsourcing as these are often overlooked by an insured.

Finally, if there is a measurable loss of finished goods production, you must determine if it results in an actual sustained loss of sales. This will depend on the circumstances and, again, a good understanding of the insured’s business is necessary to make this determination.

For example, if the insured produces a homogenous type of product and maintains an inventory of finished goods, then this may provide a buffer against a sales loss. Alternatively, if the insured’s business is such that if it misses sales on a particular day and these losses cannot be made up, then it has likely suffered a sales loss.

Typically a quick measure of the gross profit loss can be determined based on the net sales value of the product less all of the variable costs that are saved as a result of not producing and selling the product.

While this is not necessarily a simple answer, it is indicative of the thought process necessary to measure an actual loss sustained under a business interruption policy.