Insurance policies generally state that in determining the Actual Loss Sustained under business income coverage, consideration must be given to actual experience of the business before and the probable experience thereafter had no loss occurred. Thus, the goal in evaluating a business income loss is to create an accurate estimation of the business’ future earnings had the loss never occurred.
On occasion, as forensic accountants we have been asked, “Why don’t you use a consistent trending method on all losses?” or, “Why do you use an average on one loss and a sales trend on another?” or, “Why do you use a three-month trend on one loss and a twelve month or longer period on anther?”
These are all valid questions; however, since every business income loss is a unique event, it is impossible to develop one industry standard that will apply to all losses.
Sales trends are probably the most common method for projecting sales. However, care must be exercised to make sure that the pre-loss trend provides a reasonable expectation of the sales for the loss period. Inconsistencies and abnormalities must be identified and discussed with the insured to ascertain whether they should be included in the trend.
In all cases, actual pre and post-loss sales levels should be reviewed and out-of-pattern fluctuations discussed. In addition, it is important to determine if the actual cause of the sales shortfall is all directly loss related. Comparing trends, averages, budgets, industry statistics, similar locations, etc. are all effective ways to decide if the claim projection is logical.
Additional factors to consider include the economy, weather conditions, holidays and vacations. Also, some businesses operate on a 4-4-5 accounting month vs. a traditional calendar month; approximately every six years, these businesses will have a six-week month that can skew a trend for the loss period.
For a retail operation experiencing a partial suspension of operations, it is important to review the monthly loss amounts. Large fluctuations the loss amount need further investigation; if the monthly loss amounts are consistent, the trend should be accurate.
Start-up operations with little or no historical sales or production experience present their own special challenges. In these instances, pre-loss budgets or forecasts can be correlated with the actual sales results after the business resumes operations to develop a reasonable sales projection. Further, dramatically increasing trends during the start-up phase are not an indicator that sales will always remain at this high level.
Finally, significant economic events or market conditions should be considered when determining the loss. Market conditions can be accounted for in a number of ways including market share studies, economic statistics and indicators or the use of other locations that operate in a similar market.
In conclusion, past experience can be a starting point for forecasting sales, but it may not provide the entire answer. If historical sales demonstrate a uniform pattern, sales trends will be a good method for forecasting sales. However, in other instances, additional methods must be utilized to arrive at an appropriate conclusion.