Hey, small business owners!
Do you know your “earnings capacity” and why it’s essential to know that?
My name is Jerome Paige.
I’m a forensic economist.
I calculate economic damages for plaintiffs and defendants in civil litigation matters.
Today, the bright side of “the dismal science” is on my mind.
That’s what we call “economics” — the dismal science.”
What’s the dismal side of forensic economics?
We estimate the financial damages self-employed individuals (owner-workers) suffer when someone has hurt them, and they can’t earn a living or experience a reduction in their capacity to earn.
What’s the bright side?
We can clarify our value as an “owner-worker.”
As an “owner-worker,” our “labor” is the primary generator of our business’s revenues.
That’s how the economic damages literature designates us. We’re “entrepreneurs.” We’re the “magic sauce” that turns our labor, the labor of others, and other resources into goods and services that meet “unmet” or “met “needs in new ways. We’re the “creators” of economic activity.
Assume that we:
- Provide a significant amount of time in our business.
- Are injured in an accident and can’t work or have a reduced capacity to work.
- Suffer an impairment of our ability to earn income.
When an owner-worker suffers a “personal injury” due to someone else’s negligence, my job is to determine how much compensation they’ll need to replace their lost earnings. Sometimes for the plaintiff. Sometimes for the defense.
If I’m working on a wrongful death matter, I estimate what’s due to the estate of the owner-worker.
Thus, my advice to owner-workers:
Sharpen your understanding of your “earnings capacity.”
We refer to our “business profitability” as our “net profit” or “net income.” It’s the money we use to compute our income tax bill. Let’s call this “net business earnings.” Sometimes they are positive, zero, or negative. However, it’s problematic to base economic damages solely on “net earnings.”
Why?
If net income is zero or negative, there could be the argument that an owner-worker doesn’t have any financial damages even though they’re injured.
In this situation, they may be using the wrong measure (net income). In some cases, they should be using the owner-worker’s loss of “earnings capacity.” “Earnings capacity” is the composite of the owner-worker’s talents, skills, and experiences and what the market will pay them. The injury has impaired that capacity.
Think of earnings capacity as a set of “comps,” like when buying a house. Or: as the opportunity cost of the owner-worker’s time.
In one defense case we worked on, the gym was unprofitable, but the gym owner-worker could have worked in several occupations. The earnings in those occupations became the basis for how we measured the economic damages.
The losses were what the gym owner could have earned if he had worked for someone else. A vocational or occupational specialist can provide those estimates. “Headhunters” give these types of assessments all the time.
Know that number.
Another measure of “capacity” is the loss of “free cash flow.” We discuss this in other blogs.
Know this number as well.
Why?
Because, in many cases, some potential damage measures include “time utilization” or the cost of replacing the owner-worker’s duties. We explore these in other blogs as well.
Keep in mind that an owner-worker could have zero net profit and still have a claim for financial losses. Or the injury could reduce their ability to operate the business to generate and expand the company’s “free cash flow.”
I’ll explore more “bright sides” of the “dismal science” in upcoming blogs.
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