Procedure of calculating loss of profit

Many commerce students are confused about how to calculate loss of profit. They know that businessman can take loss of profit, due to dislocation of business after fire to concern . It can also take with fire insurance policy. But for getting claim , the businessman want to calculate exact loss of net profit from the date of fire to that day in which business becomes normal .

Steps of calculating loss of profit

Ist step

Calculate gross profit ratio:-

As the starting point of this procedure you have to determine the value of gross profit because loss of profit is easy to calculate by multiplying Gross profit with short of sale in that disturbance period .
Net profit xxxx
Add Insured standing
Charges of lass year (+) xxxx
-------------------------------------
Gross profit of last year xxxx
-------------------------------------

Gross profit ratio = Gross profit / sale of last year X 100

2nd step

Calculate shortage in sale due to loss of fire

Actual sale of same period of loss xxxx
Add any increase in thrend of sale (+)xxxx
------------------------------------------------
xxxxx
Less actual sale in dislocation period (-) xxxx
--------------------------------------------------
Shortage of sale in dislocation period xxxx
==================================

3rd step

Calculation of loss of profit

Loss of profit = shortage of sale X G.P. rate / 100

4th Step

Total amount for claim of loss of profit

Loss of gross profit xxxx
Add increase in cost of working (+) xxxx
---------------------------------------------
xxxx
Less saving in standing charges
---------------------------------------------
Amount of claim xxxx
===================================

5th step

Apply average clause

Amount of claim = policy value / amount to be insured

Important notes

1. We will use of only less rate from following rates for calculating correct amount of loss pf profit
Net profit + Insured standing charges of last accounting year
-------------------------------------------------------------------------- X 100
Sale for the last accounting year

Or
Policy value / sale of 12 months immediately proceeding fire as adjusted for trend .

2. The Indemnity period or dislocation period which will small, that period will be fixed for calculation of claim .
3. We will calculate loss of sale on the base of future trend of sale.
4. Insured standing charges means all expenses which are mentioned in the policy of loss of profit. Businessman wants to get these expenses in the case of mishappening. We can make its list

• Traveling expenses
• Rent, rate and taxes not related with profit of business
• Advertising
• Interest on debentures and loans.
• Auditors fee
• Salaries of permanent staff
• Directors’ fee
• Salaries of permanent staff
• Wages of skilled workers
• All not described expenses must not more than 5% of described standing expenses .
  
  Explanation with example

From the following information, find out the claim under loss of profit policy :-

2007 – net profit for the year $ 10000
2007- Standing charges insured $ 6000
$ sales for 2007 $ 160000
Date of fire 1.1.2008
Period of dislocation 3 months
Sales from 1.12007 to 31.3.2007 $ 54000
Sales from 1.1.2008 to 31.3.2008 $ 19400
Indemnity period 6 months
Policy subject to average clause $ 11000
Trend in annual sales 10% increase


Solution

Ist step

Calculation of gross profit ratio

Net profit + Insured standing charges of last yea
----------------------------------------------------------- X 100
Sale of last year

10000+6000
---------------------- X 100
160000
= 10%

2nd step

Shortage of sale

Last year’s sale from 1.12007 to 31.3.2007 $ 54000
Add 10% for upward trend $ 5400
---------------------------------------------------
$ 59400
Less actual sale during dislocation period $ 19400
-----------------------------------------------------
Shortage of sale $ 40000
=====================================


3rd step

Calculate of loss of profit

Loss of sale X G.P. rate /100
40000 X 10/100 = 4000

4th step

Total amount for claim of loss of profit

Loss of gross profit 4000
Add increase in cost of working (+) nil
Less saving in standing charges nil
Amount of claim $4000

5th step

Average clause

Since the policy is subject to average clause, it is necessary to find out whether expected profit of the current year was fully insured or not .


Expected sale for current year

Last year sale $ 160000
Add :Increase in current year 10% = $ 16000
--------------------------------------------
Total sale of current year = 176000
---------------------------------------------
Profit rate 10%
The profit of current year = 176000 X 10% = $17600

But we take the policy of $ 11000

This is a case of under insurance. It means insurance company pays $ 110 of every $ 176 loss

Claim = insurance policy / insurable profit X profit lost
= 11000 / 17600 X 4000 = $ 2500

So , amount of claim would be $ 2500

Read Also

• What is insurance
• Explain the accounting procedure for ascertaining the loss of stock by fire
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