A net loss transpires when total expenses—including taxes, fees, interest, and depreciation—exceed the income or revenue generated over a specific period. This scenario contrasts a net profit, which highlights the surplus of income over expenses.
Key Takeaways
- A net loss arises when total expenses surpass the overall income produced by a business, project, transaction, or investment.
- Businesses illustrate a net loss on the income statement, effectively as a negative net profit.
- Numerous factors, such as lower revenue, increased competition, underperforming marketing campaigns, and elevated costs of goods sold (COGS), may contribute to a net loss.
Grasping the Concept of Net Loss
For a business, net loss is sometimes called net operating loss (NOL). When it comes to taxes, net losses can be carried forward into future tax years to balance gains or profits in those periods. A net loss is reflected on the company’s bottom line or income statement. The calculation for net loss or net profit is as follows:
Net Loss (or Net Profit) = Revenues - Expenses
Because revenues and expenses are aligned over a defined time, a net loss epitomizes the matching principle, a core tenet of the accrual accounting method. Expenses associated with income earned within a period are included in (or ‘matched to’) that period, regardless of when those expenses are actually paid.
When profits dip below the level of expenses and cost of goods sold (COGS) during a set period, a net loss emerges.
Contributors to a Net Loss
Declining Revenue
A primary cause of net loss is reduced revenue. This can result from strong market competition, ineffective marketing strategies, flawed pricing tactics, failure to meet market demands, or inefficient staff. Lower revenues translate into dwindling profits. When these profits sink below the combined expenses and COGS, a net loss occurs.
High Cost of Goods Sold (COGS)
COGS significantly impacts net losses. The high production or procurement cost of sold products is deducted from revenue, with the leftover amount allocated for covering administrative expenses and generating profits. When COGS outstrips the budget for expenses, a net loss ensues.
Mounting Expenses
Even if revenue targets are met and COGS is managed within limits, unforeseen expenses and budget overruns can surpass gross profits, leading to a net loss.
Excessive Carrying Costs
Substantial carrying costs, the expenses incurred for holding inventory before its sale, can contribute to net losses. These include costs like storage, insurance, and maintaining inventory.
Firms experiencing net losses won’t automatically go bankrupt; they might opt to utilize their retained earnings or take loans to offset losses temporarily. However, this is a short-term remedy, as businesses without long-term profitability can’t survive indefinitely.
Real-World Examples of Net Loss
Example 1: State Tax Credits
Imagine significant refunds are anticipated due to companies exploiting available tax credits intended to preserve jobs during a recession. Consequently, the state treasurer predicts a $99 million reduction in revenue from the state’s primary business taxes. To avoid a net loss, state officials must significantly cut current and anticipated fiscal year expenditures.
Example 2: Company A’s Financials
Consider Company A with $200,000 in sales, $140,000 in COGS, and $80,000 in expenses. Subtracting $140,000 COGS from the $200,000 sales yields $60,000 in gross profit. However, since expenses surpass gross profit, a $20,000 net loss results.
Example 3: Frozen Food Company
Suppose a company selling frozen foods needs to cover expenses like refrigerated storage, utilities, taxes, employee wages, and insurance. If sales are slow, the company retains its inventory longer, accruing additional carrying costs that can lead to a net loss.
Addressing Common Queries
Can a Company with Positive Revenues Still Experience Net Loss?
Absolutely. Despite having high sales volumes, if the costs of goods or other sales-related expenses (e.g., marketing) are too steep, a company can still incur a net loss. Other factors like taxes, interest expenses, depreciation, amortization, and extraordinary charges (e.g., lawsuits) can also transition a company from profit to loss.
What is a Net Loss Carryforward?
The IRS permits specific net losses incurred in one tax period to offset net profits earned in following periods. The 2018 Tax Cuts and Jobs Act (TCJA) altered how net operating loss carryforwards are handled. Consult a tax advisor for detailed guidance.
Is a Net Loss the Same as a Negative Profit?
Not exactly. While a ’negative profit’ is not a formal term, it is colloquially used to describe net loss. Technically, profit implies a gain, making the term ’negative profit’ somewhat of a misnomer.
Related Terms: net operating loss, income statement, accrual accounting, retained earnings.
