After the Flood

Helping clients handle disaster-related business losses.

  • CPAs CAN HELP BUSINESS CLIENTS FILE insurance claims after their business premises are damaged by fire, flood or other disaster. Claims usually are made intwo areas, property damage and loss of income.
  • IF RECORDS ARE LOST, CPAs CAN USE tax returns to help reconstruct the list of lost property. Ultimately, damaged property valuationis subject to the provisions of the client's insurance policy.
  • DOCUMENTING INCOME LOST BECAUSE of a business disaster involves a computationwith four components: projected net income, operating expenses not incurred, income earned since the disaster and extraordinary expenses incurred because of the disaster.
  • CPAs AND THEIR CLIENTS SHOULD BE prepared for insurance adjusters to question assumptions used in making insurance loss projections. CPAs should be prepared to defend their computations and have substantiating evidence available.
  • BUSINESSES SHOULD REVIEW THEIR insurance needs regularly. Having the right insurance coverage can make the difference between keeping a business alive and forcing it to close its doors forever.
CYNTHIA M. URBANI, CPA, is treasurer and controller of Society Hill Capital Management in Philadelphia.
MARTIN J. SATINSKY, CPA, is a principal of Martin J. Satinsky & Associates, P.C., in Philadelphia.

Few calls a CPA receives are more urgent: A client phones to say that last week's torrential rain storms caused flooding, destroying everything in her company's ground floor office. She is out of business. To make an insurance claim, she needs to recreate certain financial records. Can you help?

Your response: "Of course I can help; relax." The client offers her thanks, and as you put down the phone, you begin to review the steps for filing an insurance claim in your head-first, property damage; second, loss of income. This article describes how a CPA can help this client and many other small business clients like her who suffer damage to their businesses due to floods, fires or similar disaster.

What to Do When a Company Has No Past
What happens when a company has no past history on which to base its loss of income insurance claim? That was the case with a start-up manufacturing company that suffered a fire, delaying the start-up for several months. No tax or previous years' financial information was available for the accountants to use in reconstructing the company's income. Thanks to creative thinking and analysis, the accountants were able to prove that all the fire did was defer catching up to "full speed" and what the company lost were full speed sales. To make the necessary projections the accountants "moved" what actually occurred once the company was in business again back to the date of the fire. Then they took the trend of later sales and used this information to calculate the lost income.

The company was down for three months because of the fire. In the fourth month, it began to operate again and it took five months to reach full production. The insurance company argued that because this was a start-up business, the manufacturer didn't lose as much as it said it did. The accountants proved that what the company effectively lost was four full months of sales because the gear up time was deferred by the fire. It would have finished gearing up during the months it was unable to operate and would already have been fully productive.


To help the client above make her insurance claim, you check your files to see whether her company had given you all of its property records. A fat file reveals documentation for the last 10 years-more than enough to satisfy most insurers.

What if the client made the mistake of keeping all property records herself? Hopefully, she also kept a backup copy, or had maintained off-site computer files. If necessary you can obtain copies of the client's business tax returns from the Internal Revenue Service. The returns should show a correct and indisputable property listing on depreciation schedules that can be used in making an insurance claim.

It's important for the client and his or her advisers to remember that damaged property valuation ultimately is subject to the provisions of the client's insurance policy. But the skill with which the client negotiates with his or her insurance company also is important.

A business interruption insurance policy is intended to do for the insured what the business itself would have done had no loss occurred-provide income. A business owner frequently adds such coverage to an existing property policy by endorsement. A typical policy pays a business owner for the actual loss of business income resulting from the necessary suspension of operations while damage is repaired.

Documenting the income that is lost in a business disaster so a client can make a claim under his or her business interruption insurance policy is more complicated than substantiating a claim for lost property. Four basic factors figure into the loss-of-income equation.

The High Cost of High Water
From 1989 to 1993, property
losses in the United States
due to flood damage totaled
over $21 billion.
  1. Projected net income. How much would the business have earned in the period since the disaster occurred.
  2. Operating expenses not incurred. Expenses nullified by the disaster.
  3. Income earned since the disaster, if any.
  4. Extraordinary expenses incurred as a result of the disaster.

Projected net income. For the CPA to assist the client in projecting how much income the business would have earned, the loss period must be known. The disaster is the first day of this period, which ends when the business is back to normal . Of course, back to normal isn't always easy to calculate. If the client owns a retail business, for example, it may take some time for customers to switch to a new location. Even if a business has not recovered within a policy-specified period of time, the insurer may not be obligated to cover the loss if the policy limits the amount of coverage.

Once the loss period has been estimated, the CPA can calculate projected net income. The starting point is the prior year's tax returns. The CPA should make adjustments for atypical revenue or expenses, as well as any unusual changes in the business (growth, decline, new products, salary level changes). The CPA should be sure to make a list for the insurance adjuster of all the assumptions he or she made in preparing the pro forma financial statements, along with the justification for those adjustments.

Expenses not incurred. The projected net income calculated above is reduced by normal operating expenses that would have been incurred had the disaster not happened. Again, prior-year tax returns are helpful in determining normal operating expenses if, for example, staff members have been laid off as a result of the disaster-thus reducing wage expenses-or a plant stops operating, decreasing utility costs. The CPAs next step is to compare the actual operating expenses (if the business is still partially functional) with normal expenses. The difference would reduce the loss of income claim.

Postdisaster income. Income earned by the business after the disaster reduces the client's loss-of-income claim. To keep track of this, CPAs should impress on their clients the importance of keeping good records.

Extraordinary expenses incurred. Extraordinary expenses incurred by the business as a result of the disaster increase the loss-of-income claim. Clients may incur significant costs while trying to mitigate damages to their businesses. These costs-for renting temporary office space, replacing inventory, using different suppliers or outsourcing certain tasks-reduce the entity's normal profit margin. They may be covered by either the property damage or loss-of-income policy provisions.

In most cases, the insurance adjuster is more likely to question the loss-of-income claim than he or she is to question the property damage claim. Once the above calculations are completed, CPAs and their clients can expect the adjuster to question projection assumptions. CPAs should be prepared to defend them as reasonable with some form of substantiating evidence, and to have available documentation for significant expenses incurred since the disaster.

One caveat: The CPA should be careful not to include extraordinary costs such as site cleanup or employee overtime in both the property damage and loss-of-income claims. Doing so may cause the adjuster to think the claims have been artificially inflated.

What can a CPA do-before disaster strikes-to make sure his or her clients won't have to scramble to get their business back on track in the event of fire, flood or similar calamity? The checklist on page 41 lists some key questions CPAs should go over regularly with their clients to make sure they are prepared for the worst.

CPAs also can prompt their clients to review their business insurance needs on a regular basis. Having the right business interruption coverage can make the difference between keeping a business alive and forcing it to close its doors forever. Because CPAs typically are very familiar with their clients' business operations, they are in an excellent position to determine what types of insurance are appropriate and how much coverage is necessary.

For CPAs, helping a client present his or her insurance claims professionally provides that client with peace of mind at a time when it is in very short supply. Even more important, CPAs can offer true peace of mind by assuring clients that the business insurance they maintain is sufficient to protect them from virtually any disaster.

Business Disaster Recovery Checklist

To prepare for a possible disaster, clients should ask themselves these important questions:
  1. Do you periodically review your insurance coverage, know exactly what your insurance policy covers and keep a copy of the policy offsite?
  2. Do you regularly back up all computer program and data files?
  3. Do you keep a copy of your computer backup offsite?
  4. Have you looked into where to obtain temporary equipment to keep your business going?
  5. How would you quickly replace your inventories if lost?
  6. Where would you maintain inventory if your storage facility was damaged?
  7. Where would you manufacture your product or operate your business if your primary location was damaged by fire or flood?
  8. Which employees perform key functions?
  9. If certain employees were unable to work, have you identified replacements, either within the organization or through the use of temporary employment agencies?
  10. Do at least two employees know how to perform all key functions and do you maintain up-to-date procedure manuals?


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Black CPA Centennial, 1921–2021

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