How to calculate consequential loss: navigating business interruption claims

Unforeseen disruptions to your business operations can strike at any time, and the resulting claims can be a daunting prospect for any business owner. Understanding the financial ramifications of business interruption is crucial to ensure the swift recovery and operational stability of your business when making a claim.

Calculating consequential loss is an important aspect of navigating business interruption claims, and this article serves  to help you to assess and determine your consequential loss total, equipping you with the knowledge and tools to effectively manage disruptions and optimise your recovery efforts.

What is consequential loss?

Consequential loss refers to the indirect financial losses your business may suffer due to an insured loss, such as damage to property, equipment or employee injury or death.

Unlike direct losses, which insure directly against physical damage or loss, consequential losses stem from the interruption of business operations or the impact on revenue streams.

These losses can include business interruption, loss of profits or income, additional expenses incurred to resume operations, and other related costs. Consequential loss cover provides financial protection to businesses against such indirect losses resulting from insured events.

Key factors that can influence your consequential loss total

1. Nature of business:

Different industries have varying vulnerabilities to consequential loss. For example, a manufacturing company may suffer significant losses due to production downtime, while a service-based business might lose clients during interruption periods.

2. Extent of damage:

The severity and extent of damage to property, equipment, or assets can directly impact the consequential loss. More extensive damage typically leads to longer recovery times and higher financial implications.

3. Length of business interruption period

The duration it takes for your business to resume normal operations after the insured event plays a crucial role. Longer interruption periods generally result in higher consequential losses due to prolonged revenue loss and increased expenses.

4. Revenue streams

The sources of income for your business, such as sales, contracts, or services rendered, affect the magnitude of consequential loss. Businesses heavily reliant on a single revenue stream may suffer more severe financial setbacks if that stream is disrupted.

5. Cost structure

The fixed and variable costs associated with running your business influence a consequential loss total. Businesses with high fixed costs, such as rent and salaries, may face greater challenges during interruption periods compared to those with more flexible cost structures.

6. Mitigation measures

The effectiveness of good contingency plans and risk mitigation strategies can reduce the impact of consequential loss. Businesses that have robust backup systems, alternative suppliers, or business continuity plans may experience lower losses during interruptions because of their forward planning.

7. Insurance coverage

Insufficient coverage may leave gaps that expose the business to greater financial risks. Inadequate coverage including poor consequential loss cover can directly affect the extent of financial protection available.

The three steps to calculate consequential loss

1. Assess your business interruption period

Determine an accurate time frame for  a period of business  shut down due to a major loss. Consider the total recovery time, how long it took your business to restore production, the time it took for your systems to get back online, etc.

2. Estimate your gross profit loss

Consider your revenue streams, fixed costs and variable expenses to calculate your gross profit loss. You can do this by calculating your expected gross profit during the period of business interruption, minus your actual gross profit. This represents the shortfall or loss in gross profit due to the event.

3. Analyse additional expenses

If the event incurs additional expenses to maintain operations or resume normal activities, these should be factored into the calculation. Include any extra costs incurred beyond the usual operating expenses.

Are there any exclusions?

Consequential loss cover may not cover certain situations. Some general exclusions may include:

• Loss of gross profits resulting from fire or special perils not covered by the policy that cause damage to business property
• Losses due to material damage to your business property
• Loss of goodwill and any third-party claims arising from the events
• Claims resulting from war, invasion, or acts of a foreign enemy