How to Calculate Business Interruption Insurance

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This could happen to your business
This could happen to your business

If a business has a temporary shutdown due to fire or other insured peril, business interruption insurance can be invaluable. Business interruption insurance generally insures loss of net profits and continuing expenses. It can also pay for expenses incurred if the business has to move to another location due to a covered insurance event. This type of insurance is also known as profits insurance or income insurance. Business interruption insurance is not sold as a policy by itself but is usually part of a property insurance or business owners policy.

Calculate the net sales of the business. This figure is arrived at by subtracting adjustments from gross sales. Adjustments would include but not be limited to discounts given, returns and allowances, bad debt and freight. Calculate total revenues by adding net sales and other income that would be lost if normal business operations were interrupted. Other income could include but not be limited to rent, interest and service fees.

Calculate the gross earnings of the business. This figure is the result of the total revenues minus merchandise or materials consumed. There are two factors which make up the merchandise and materials consumed. The first is purchases during the year. The second is the change in inventory which is the result of the beginning inventory minus the ending inventory.

Calculate the gross sales after discontinued expenses. Discontinued expenses are those which will not be incurred during the time of the interruption. These expenses could include payroll that would not continue, rent, utilities, delivery, advertising and maintenance. Subtract the total of the discontinuing expenses from the gross earnings.

Determine the amount of business interruption insurance you require, in terms of duration. There is no particular rule to determine that duration; it is a matter of how long you believe it would take you to rebuild the business in a worst case, and the advice of your insurance professional.

If you feel you require six months of insurance, multiply the gross earnings after discontinued expenses by one-half (0.5). If you require nine months of insurance, multiply the gross earnings after discontinued expenses by three-quarters (0.75). And if you require a whole year of insurance, multiply the gross earnings after discontinued expenses by one (1.0).

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