The accountant's definition of gross profit vs. the insurer's definition

A common problem with Business Interruption insurance is that the accounting terms such as ‘Gross Profit’ and ‘Gross Income’ used in insurance policies do not have the same meaning as when used by accountants or other business personnel.

Sadly, this is a mistake which is often not realised until a claim occurs with inevitably disastrous results for the policyholder. If you have underinsured, and the Gross Profit figure is vastly below the required level, then the policy will be unable to operate as intended and the claim settlement will be less than is needed. This ultimately jeopardises your organisation’s ability to recover and may cause it to fail entirely.

The difference in definition between Accounting Gross Profit and Insurable Gross Profit occurs most often in manufacturing risks. An accountant is trying to determine the exact cost of goods sold. Manufacturers costs, such as direct materials, direct labour (wages), and factory overheads, are captured and deducted from sales turnover to arrive at Accounting Gross Profit.

On the other hand, Insurable Gross Profit is generally defined as:

The sum of the Turnover and the amount of the Closing Stock and work in progress less the sum of the amount of the Opening Stock and Work in Progress and the amount of the Uninsured Working Expenses.

Do consider carefully what your Uninsured Working Expenses may be. These are the expenses of the business that vary in direct proportion to a change in turnover.

You will still need to pay wages (potentially further wages for overtime) and for power costs such as for light and heat (just as examples). Purchases are a consideration to be deducted as Uninsured Working Expenses and it is thought that these should really be the only expenses to be deducted. However, even purchases need to be considered carefully as for some businesses that have to forward contract for purchases, they may not, in fact, be able to “turn off” their purchases in the event that sales are reduced following an insured incident.

When you consider any expense, it is important to consider what would happen to the expense in the event of a partial loss, not just a total loss.

If in doubt, insure it!