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The Treatment of Fixed Costs and Overhead in Lost Profit Calculations by Scott Bouchner, CMA, CVA, CFE, CIRA

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Posted on February 04, 2025 by Scott Bouchner

In commercial litigation matters involving contract disputes, claims of fraud, negligence, intellectual property infringement and other tort actions, lost profits may be an appropriate measure of damages to make the injured party financially whole provided the plaintiff can a) establish that the defendant’s actions caused the economic loss and b) the amount of the loss can be calculated with reasonable certainty.

Plaintiffs, however, bear the burden of quantifying the profits they would have otherwise earned “but for” the defendant’s alleged wrongdoing in contrast to the actual profits (or losses) that were generated or will be generated as a result of the defendant’s actions. In doing so, plaintiffs and their counsel must consider several variables that could impact their damages calculations, including the distinction between fixed and variable costs and the courts’ sometimes conflicting opinions on the treatment of these expenses.

Any discussion about lost profits must begin with an understanding that such damages are not the same as a loss of revenues or gross profits. Rather, any calculation of lost profits must give some consideration to the costs a plaintiff avoided as a result of the purported loss in revenue, which may be offset by the additional expenses incurred by the plaintiff because of the defendant’s wrongful act. More specifically, Florida law states that damages are “the amount that the innocent party would have received if the contract had been performed, less any deductions for expenses not yet incurred.” (9A Fla.Jur., Damages, § 27.)  “The recovery should include any gains prevented and losses sustained, including the loss of prospective profits.”  (9A Fla.Jur., Damages, § 82.)

To accomplish this, it may be appropriate to perform an analysis of the plaintiff’s financial operations both before and after the alleged bad acts by the defendant to better understand and distinguish their fixed costs from their variable costs. Fixed costs are generally defined as the recurring overhead expenses a company incurs regardless of how much business it conducts or how many goods or services it produces or sells. These overhead expenses, including rent and depreciation, generally do not change with a rise or fall in sales. However, variable or avoided costs, such as labor and supplies, can fluctuate and change based on the result of actual events.

Depending on the business and the loss period, there are times when the characteristics of fixed and incremental costs can change. For example, the rent a manufacturer pays to store its materials and supplies is often considered a fixed cost. However, if the business increases the production of a particular product to meet immediate market demand, it may require additional space and higher rent, which some courts may consider semi-fixed costs the company should deduct from a lost profits claim.

In many jurisdictions, courts require plaintiffs to calculate the net incremental revenue they would have realized but for the defendant’s misconduct and reduce that amount by the related incremental costs they avoided. In Florida courts, however, the distinction between fixed and variable costs may be less important, and there has been some division within the courts on which fixed and variable costs are deductible based on the type of matter and specific facts and circumstances of each case.

To demonstrate just how varied the court has ruled on these matters concerning the deduction of fixed costs in lost profits calculations, the following is a brief historical overview of some of the differing opinions issued by Florida Courts over the past four decades.

Knight Energy Services, Inc. v. C.R. International Enterprises, Inc. (1993)

Florida’s Fourth District Court of Appeals affirmed the trial court’s decision that the plaintiff presented sufficient proof to establish a lost profits claim stemming from a breach of contract and was entitled to the contract price less any deductions for costs and expenses necessary to fully perform the contract.” However, the court accepted the plaintiff’s “unequivocal testimony” on cross-examination “that there were no deductible overhead costs or expenses necessary to fully perform this contract” and awarded the plaintiff the full $91,000 requested without any required overhead cost deduction.

Murray v. Department of Transportation (1997)

The Florida Supreme Court ruled that a “business-loss calculation based on certain variable expenses and excluding some fixed expenses can be cognizable under section 73.071(3)(b), depending upon the factual circumstances of a particular case.” In doing so, the court quashed the district court’s decision and accepted the plaintiff’s expert’s analysis that some of a restaurant’s fixed costs would be the same even if it lost some of its parking spaces through eminent domain.

Boca Developers, Inc. v. Fine Decorators, Inc. (2003)

Florida’s Fourth District Court of Appeals held that in a breach of contract claim for lost profits, fixed overhead costs, including rent, employee salaries and insurance, should be allocated to a damages calculation “across the board,” especially when the injured party lacks evidence suggesting that those expenses were not involved in the performance of the contract. In this case, the breaching party apportioned its fixed costs across other contracts but not to the contract at issue. The appellate court reversed the trial court opinion, adding that if the trial judge had correctly ruled that overhead had to be deducted, “Fine would have been able to establish the amount of that overhead and should be given the opportunity to do so.”

RKR Motors, Inc. v. Associated Uniform Rental & Linen Supply, Inc.

Florida’s Third District Court of Appeals ruled certain fixed overhead costs are integral to parties carrying out a contract and, therefore, should be deducted in lost profits calculations to “allow for a true measurement of the amount the non-breaching party would have earned on the contract had there been no breach, which is the proper measure of damages. The court reasoned that not requiring such an allocation of fixed costs would lead to “absurd results.”

The court noted that the “correct method in determining lost profits is not to subtract only those expenses that would not be ‘saved’ or reduced by not performing the breached contract…[but] to subtract all costs related to performing the contract.”  Because Associated failed to identify any costs that were not required to perform the contract, the appellate court accepted allocating all variable and fixed costs to calculate lost profits. Ultimately, the court concluded that the intuition underlying Florida’s contract cases is that all costs involved in performing a contract must be deducted from the contract price to ensure that the non-breaching party does not get a windfall.

James Crystal Licenses, LLC v. Infinity Radio, Inc. (2010)

Defendants appealed a second trial court decision to award the plaintiff lost profits in connection with defendant’s breach of a non-compete agreement. In its opinion, the appellate court agreed with defendants that the plaintiff failed to deduct general overhead expenses beyond sales commissions and talent fees from its damage calculation and, therefore, fell “short of the burden it carried to provide competent substantial evidence that the losses were directly linked to the defendants’ alleged wrongdoing. We, therefore, reverse the compensatory damages award.”

Conseal International Inc. v. Neogen Corp. (2020)

Unlike the previously cited state cases, this was a federal matter before the U.S. District Court for the Southern District of Florida in which a defendant challenged the reliability of the plaintiff’s expert’s report, claiming it 1) computes the plaintiff’s gross lost profits rather than the net lost profits required under Florida law and 2) fails to account for fixed costs and overhead expenses relating to plaintiff’s operations. The court agreed, citing Boca Developers, Inc. v. Fine Decorators, Inc., that “if a company performs 100 jobs per year, “and its fixed costs do not increase after the first fifty, it does not follow that [it] can recover greater lost profits for the seventy-fifth [job] than the twenty-fifth [job]. [Rather, Florida] case law requires that these expenses be allocated across the board.”

Financial Information Technologies v. iControl Systems (2021)

A jury trial found the defendant violated the Florida Uniform Trade Secrets Act (FUTSA) by misappropriating the plaintiff’s trade secrets. The defendant appealed, claiming that the plaintiff’s “alleged trade secrets were readily ascertainable—and thus not secret” and challenging the plaintiff’s lost profits damages because “it hadn’t deducted fixed and marginal costs from its revenue calculations.” Concerning last profits, the United States Court of Appeals, Eleventh Circuit, noted that “Florida courts recognize that this contract-based damages methodology is different from a calculation of “actual costs.” Under FUTSA, damages are permitted “only for ‘the actual loss caused by misappropriation.’ Fla. Stat. § 688.004(1).

Accordingly, Florida’s method of calculating damages in breach-of-contract disputes does not necessarily carry over into FUTSA cases. It, therefore, agreed with the district court that the jury was not required to deduct Fintech’s fixed costs from its revenues to arrive at a proper “actual loss” measure.

With this analysis, it is critical to include forensic accountants in calculating damages to ensure a thorough analysis of all the relevant facts and circumstances relating to claims of lost profits. While some courts have ruled that apportioned overhead expenses must be deducted from an award of lost profits, other courts have taken the view that general fixed expenses, such as overhead, should not be deducted unless they are directly attributable to the lost transaction and would have been saved by not performing the contract.

About the Author: Scott Bouchner, CMA, CVA, CFE, CIRA, is director-in-charge of Forensic and Advisory Services with Berkowitz Pollack Brant CPAs + Advisors, where he serves as a litigation consultant, expert witness, court-appointed expert and forensic investigator on several high-profile cases. He can be reached at the CPA firm’s Miami office at (305) 379-7000 or info@bpbcpa.com.