Make-Up Revenues

Understanding Make-Up Revenues in Business Interruption Claims

When a business experiences a loss event, such as a fire, flood, natural disaster, or other covered event, it may result in lost income during the period of restoration. However, one important factor in accurately calculating business interruption (BI) losses is recognizing the impact of make-up revenues. These revenues, earned after the loss period, can sometimes offset lost income and significantly influence the final loss calculation.

What Are Make-Up Revenues?

Make-up revenues refer to sales or earnings that a business “makes-up” after resuming operations following the loss period. These revenues occur when customers defer purchases or the company increases capacity after the loss period to recover lost business. For example, if a company operates at 100% capacity under normal conditions, they may increase production to 150% after the loss period to compensate for lost production. This post-loss increase needs to be considered and netted against the lost production during the loss period.

Industry-Specific Considerations

The impact of make-up revenues varies across industries. Some businesses, like professional services firms, can recover lost work by reallocating resources or increasing billable hours. Additionally, businesses with multiple locations may increase volume in another location while being down at the other location. Retail businesses, on the other hand, may find it harder to recover lost foot traffic, especially if customers have turned to competitors during the downtime. Similarly, industries with perishable goods or seating capacities, such as restaurants, may have no opportunity to make up for lost sales.

Key Factors in Evaluating Make-Up Revenues

When assessing make-up revenues, forensic accountants consider several factors:

• Timing: The period in which the revenues are earned is another crucial consideration. It is important to recognize if the company operates on a cash or accrual basis. Make-up revenues may be harder to detect if the company operates at a cash basis. For example, if a company increases its services immediately after the loss, but does not recognize those revenues until cash is received months later, the make-up revenues may be overlooked.
• Location Logistics: Businesses that have multiple locations may see make-up revenue during the loss period at an alternate location. For instance, if the company has two locations within a 10-mile radius, it is likely that customers will just go to the unaffected location. Because of this, it is important to request the companies profit and loss statements from all locations so that you can evaluate if make-up occurred.
• Capacity Constraints: Some businesses, like manufacturers, may be able to increase production post-loss, while others, such as event-based businesses, may have no means to recover lost revenue. For example, manufacturing facilities may have their workers work extra shifts once the facility is back up and running, so that they make up their lost production quicker than they would if they were operating at a normal speed. The increased production may reduce lost income if they are able to fulfill orders at a normal pace.
• Customer Behavior: If customers simply delay purchases until after the business reopens, those revenues should be considered when assessing net losses. This is an important consideration in medical practices. For instance, if a dentist or doctor experiences a short-term disruption, patients are unlikely to switch providers. Instead, they will typically wait until their provider resumes operations.
• Competitive Impact: If a business loses customers permanently to competitors, future sales may not offset the loss, even if revenues temporarily increase. Competitive impact is important to recognize in specialized businesses. If a company offers a unique product that is difficult to find elsewhere, it is more likely to recover lost sales after the disruption. However, if the business lacks specialization and experiences a longer loss period, customers are more likely to seek alternatives, reducing the potential for make-up revenue.

Why It Matters

Properly accounting for make-up revenues ensures that business interruption claims are fair and accurately represent true financial losses. Overlooking make-up revenues may lead to overstated claims, while failing to identify lost opportunities can result in undervaluation.

Conclusion

Understanding make-up revenues is essential in BI loss calculations. Forensic accountants play a key role in this process by applying detailed analyses to ensure accurate and supportable loss calculations. If your business is navigating a BI claim and needs assistance, consulting with an experienced forensic accountant can help clarify these critical issues and support a well-founded claim.