Lines "A" through "H" on page 2 of the business income report/worksheet are designed to develop the total revenues (as defined by the CP 15 15) of the insured entity. The last commentary defined and detailed the worksheet's first four lines ("A" to "D") which apply mainly to manufacturing risks (where manufacturing operations must complete all four lines, non-manufacturing insureds must only provide line "A" (Gross Sales) data).

The next four lines/sections, "E" through "H," apply to both manufacturing and non-manufacturing insureds with only minor deviation in the area of Net Sales - line "F." Each line/section is detailed below.

Completing the Worksheet - Continued

Cost of Sales, Unrealized Income and Collection Expenses: Section "E" applies to both manufacturing and non-manufacturing insureds. Three categories of expenses and costs are captured in this section: 1) sales expenses; 2) unrealized income; and 3) collection expenses.

Cost of Sales: As the title suggests, these are sales-related expenses that must be deducted from gross sales to develop the net sales value of production or net sales (based on the insured's classification as a manufacturing or non-manufacturing operation). Pre-paid outgoing freight, returns and allowances and discounts are "costs" associated with the post-production sales process and thus reduce the amount of revenues and ultimate income realized by the insured and available to pay operating costs. These costs will not continue after a loss with the possible exception of costs associated with a return (i.e. a buyer returns a purchase within a specified time expecting a refund) since there is no or limited production and/or sales.

Bad Debt: Bad debt is money that cannot be collected from buyers. Since the business income worksheet is completed on an accrual basis (rather than a cash basis), bad debt is unrealized income that was included in gross sales figure and must be deducted to generate true revenues available to operate the business.

Collection Expenses: Like bad debt, collection expenses reduce the amount of cash available to cover business-related expenses and generate a profit. Collection expenses as reported in the business income worksheet represent the cost of outside collection agencies or other third parties hired to recover payment from buyers. This does not contemplate or exclude the costs of employees involved in debt collection.

Bad debt and collection expenses may actually increase following a business-closing loss as those that usually pay simply decide to wait or not pay at all; and those that are generally slow pay decide not to pay. Both situations may require the insured to hire a collection agency and/or write off the debt. Are these increased bad debt and collection expenses excluded from compensable business income since these costs are being deducted during the calculation process? If the letter and apparent intent of the policy wording is followed, any increase in bad debt and/or collection expense should be covered by the policy.

The business income policy states that loss will be determined based in part on the "likely Net Income…if no physical loss or damage had occurred…." If the insured historically and consistently experiences bad debt and collection expenses equal to 3 percent of total revenues, yet that number jumps to 6 percent following a business-closing loss, the additional 3 percent is logically attributable to the loss causing the shut down. The insured should be able to successfully argue that any spike in bad debt and collection expenses lowers the "likely net income" and should be part of the compensable business income.

These costs and expenses are subtracted from the calculation of the ultimate business income because they are purportedly non-continuing operational expenses, directly related to the sales process (a.k.a. non-continuing sales-related operational costs). Since there are essentially no sales and thus no sales expenses, these amounts do not factor into the coverage provided by business income form.

Net Sales (non-manufacturing)/Net Sales Value of Production (manufacturing): (Line "F") This is gross sales (Line "A") minus sales expenses, bad debt and collection expenses (section "E") for non-manufacturing operations; and gross sales value of production (line "D") minus sales expenses, bad debt and collection expenses (section "E") for manufacturing operations.

Other Earnings: Section "G" allows the insured to account for earnings not related to sales. These earnings may include commissions or rents; Cash discounts that have been received; or any other non-sales earnings with a few exceptions. The exceptions to this "other earnings" section are investment income and rents from other properties.

Essentially, the only "other" income the insurance carrier desires to insure is income directly related to the presence of the building. Presumably, investment income will continue to flow in even if the building is not there. Likewise, the destruction of the building(s) at the insured location will not (or should not) lower rental income from owned property at another location just because the building is not there (provided the rental property is located someplace else).

An important term is this section is "your." The worksheet requests that the named insured(s) add other earnings "from 'your' business operations." To be included in this calculation, the eligible other income must be assignable to the policy's "you."

Total Revenues: All this adding and subtracting going back to the previous post has finally brought us to the end of the income section of the business income worksheet a produced the total revenues (Line "H").

Coming Next

For all the information on Business Income coverage, take a look at Insurance Journal's book, "Business Income Insurance Demystified: The Simplified Guide to Time Element Coverages."