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 profitIst stepCalculate 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 stepCalculate shortage in sale due to loss of fireActual 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 stepCalculation of loss of profitLoss of profit = shortage of sale X G.P. rate / 100
4th Step
Total amount for claim of loss of profitLoss of gross profit xxxx
Add increase in cost of working (+) xxxx
---------------------------------------------
xxxx
Less saving in standing charges
---------------------------------------------
Amount of claim xxxx
===================================
5th stepApply average clauseAmount 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
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