Accounting Gross Profit does not equal Insurable Gross Profit
One of the problems with business interruption insurance is that the accounting terms such as Gross Profit and Gross Income used in insurance policies does not have the same meaning as accountants or business people use. The important differences are not usually taught at university and so clearly there is potential for misunderstanding. Sadly this is a common mistake which is often not realised until claim time often with disastrous results for the policyholder.
The difference in definition between Accounting Gross Profit and Insurable Gross Profit occurs most often in manufacturing risks. The cost accountant is trying to determine the exact cost of goods sold. All the costs of manufacture such as direct materials, direct labour, and factory overheads are captured and deducted from sales turnover to arrive at accounting gross profit.
Note: The amounts of the Opening and Closing Stocks and Work in Progress shall be arrived at in accordance with the Insured’s normal accountancy methods, due provision
being made for depreciation.”
(Note business packs may or may not use this definition. Please review what is covered with your insurance broker or adviser.)
To be fully insured under a business interruption policy only those expenses, which are truly variable in direct proportion to sales, should be listed as an Uninsured Working Expense and not insured. Purchases are a good example. However, many other expenses may not slow at the same rate as sales revenue in the event of a disruption.