Introduction to Business Income Loss

By Paul L. DeBoer, CPA/CFF, CFE

Contributed by RGL Forensics

ONE of the challenges for business entities, owners and managers today is navigating the world of insurance in order to select insurance coverage that will adequately protect the business entity should a loss event occur. That exercise requires contemplation of unknown future events, evaluation of different types of insurance coverage and consideration of how to track the operations of the business in case a covered loss occurs.

Depending on the type of entity and nature of its business operations, there are several types of coverage that should be considered. In addition to the typical coverage for physical damage to property and the contents located at the business’ premises, an entity should consider coverage for business income and extra expenses. Business income and extra expense coverage is intended to replace the business’ profits while it is unable to operate following a covered loss, allow it to stay in operation should an event not completely interrupt operations and/or return to normal operations as quickly as possible.

Easing the Process

Many times when a covered loss event occurs, it is the first time that a business entity, owner or manager has experienced such a catastrophe. As a result, they are typically unfamiliar with the claims process or how to quantify their business income loss.

Following a few simple but strategic steps can prepare the business entity, owner and/or manager in advance of an event and smooth the process after one has occurred.

1. Know the Details of the Insurance Contract

Many times, a business entity, owner, and/or manager does not know what the insurance contract, or policy, provides as protection. As a general rule, business income insurance affords a business entity a reimbursement of lost earnings, not lost revenue. Each policy provides a specific definition of business income and extra expense and the related terms that are pertinent to the coverage. The following is an example of language typically found in the insurance policy.

Business Income is the sum of: “the net profit, which is thereby prevented from being earned, and all charges and expenses (including ordinary payroll), only to the extent that these must necessarily continue during the interruption of business and only to the extent to which such charges and expenses would have been earned had no loss occurred.”

Extra expense means:

“the excess of the total cost incurred during the period of restoration of the damaged property necessary and reasonably chargeable to the operations over and above the total cost that would normally have been incurred to conduct such operations during the same period had no loss or damage occurred.”

2. Maintain Proper Supporting Documentation

A business owner will typically need to provide access to their books and records in order to properly support and quantify a claim for loss of business income. The business entity should keep accurate and complete financial records in order to demonstrate its historical operations, as well as, its operations during a period of interruption. The following is a list of the basic financial records that are typically necessary to properly evaluate a loss of business income.

  • Monthly revenue for several years prior to the loss event.
  • Detailed annual profit and loss statements for several years prior to the loss event.
  • Monthly profit and loss statements during the period of interruption.
  • Payroll registers for pay periods prior to, during and following the period of interruption
  • Supporting documentation (such as expense invoices, cancelled checks, etc.) for extra expenses incurred during the period of interruption.

3. Be Prepared

Being prepared can be a key factor in mitigating the damaging effects of a covered loss event. In addition to the items discussed above, a business entity can benefit from having a disaster recovery plan in place. Considering the types of events that could potentially occur and evaluating what steps would be taken if an event occurs can assist a business entity in effectively managing a catastrophe. It is also important to consider if financial records could be lost and if appropriate safeguards are in place to replace/restore the financial data.

A Case Study Example

The following is an example of a business entity that experienced a business income loss following a covered loss event.

The Mountain Top Recreation Center* is a full service recreation center operated by the small city of Mountain Top*, Colorado. The recreation center includes outdoor fields, basketball and tennis courts, picnic areas, an indoor gym facility, swimming pool, snack shop and gymnasium. On February 5, 2014*, a sprinkler head adjacent to the wall of the gym broke and water flooded the gym’s wood floors forcing the gym to be closed until the floor could be replaced.

Mountain Top used the gym to host recreational sports team practices and games, as well as, special events. Mountain Top charged user fees, either monthly memberships or day passes, for the use of its facilities. Because the gym could not be used for a number of months, Mountain Top made a claim for loss of business income during the period of repairs. Mountain Top’s claim included the business income loss it sustained when some of its events were cancelled and also the extra expenses it incurred to rent space at other facilities in order to maintain some of the reservations, activities and revenue.

With proper planning and use of the extra expense coverage it purchased, Mountain Top was able to maintain events, such as the Daddy/Daughter Sweetheart Dance on Valentine’s Day and the weekly youth basketball leagues, by renting other facilities. In addition, Mountain Top was able to receive reimbursement for its business income loss that resulted from the cancellation of some of its other special events and daily/monthly fees that were lost due to the lack of use of the gym facility.

Mountain Top was able to demonstrate its losses by submitting detailed financial statements for each segment of the recreation center’s operations. The reported historical operations facilitated the quantification of the events that were not able to be held and the volume of day passes and memberships that were lost due to the damaged facilities.

*Note that the entity name, location and dates have been changed for confidentiality.

In Summary

Any business entity that has sources of revenue that could be interrupted if the business were to suffer from a catastrophic event should consider if it needs and/or has the proper amount of business income and extra expense coverage. Understanding the coverage that is available and/or already in place, maintaining the proper financial records and being prepared for potential loss scenarios that exist can add a level of confidence for business entities, owners, and managers should a loss event ever occur.

About the Author

Paul L. DeBoer, CPA/CFF, CFE is a forensic accountant with the international firm of RGL Forensics. Mr. DeBoer has focused his entire career on measuring economic damages and lost earnings for business entities and individuals, and routinely assists insurance carriers and self-insurance pool administrators in evaluating loss of business income.

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