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Loss of profit insurance, a type of business interruption insurance, reimburses business owners for gross profit lost due to an insured incident or disaster. To calculate gross profit for an insurance claim, multiply lost sales by the product's gross profit rate.
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Gross Profit for Insurance Purposes
Your insurance policy documents dictate exactly how gross profit is calculated in the event of a claim. However, insurance company Cunningham Lindsey asserts that most insurance policies use a conventional definition. Under this definition, gross profit is calculated by multiplying the gross profit rate by the amount of turnover -- also known as sales revenue -- lost as a consequence of the event.
Step 1: Calculate the Gross Profit Rate
Determine your gross profit rate for the product affected by the insured event. For the purposes of the insurance calculation, gross profit rate is the product's selling price less the product's direct costs divided by the product selling price. Direct costs include materials, freight and packaging.
For example, say that you typically sell a product for $50 per unit and materials, freight and packaging cost $30 per unit. Your gross profit on the product is $20 -- $50 minus $30 -- and your gross profit margin is $20 divided by $50, or 40 percent.
Don't confuse the insurance-specific definition of direct
product with cost of goods sold. Unlike cost of goods sold, direct product cost doesn't include manufacturing overhead or labor expense.
Step 2: Determine Lost Sales Due to the Incident
Calculate the reduction in sales due to the covered incident for the amount of time that your insurance policy specifies. According to Zurich. an insurance company, coverage typically begins the day the damage occurs and ends the day the damage is, or should have been, repaired. You can calculate lost sales comparing this year's product sales to historical sales data, adjusting for any trends or variations as necessary.
For example, say your insurance will cover losses during March due to a natural disaster. Assume that sales during this month for the affected product were $6,000. If historical data shows that you typically sell $10,000 of revenue from this product in March -- and there is no reason to think that you wouldn't sell this much if the disaster hadn't occurred -- your reduction in sales is $4,000.
Step 3: Find Gross Profit for the Claim
Multiply the dollar value of lost sales from the covered incident by the gross profit rate to determine the gross profit for the loss of profit insurance claim. In this example, gross profit would be lost sales of $4,000 multiplied by a gross profit rate of 40 percent for a total of $1,600.