What is a net loss?
A net loss is when total expenses (including taxes, fees, interest, depreciation and amortisation) exceed income or revenue generated in a given period. A net loss can be compared to a net profit, which is also referred to as after-tax income or net income.
Understanding net loss
For a company, net loss is sometimes referred to as net operating loss (NOL). For tax purposes, net losses may be carried forward into future tax years to be offset against profits in those years. A net loss is recognised in the company’s income statement. The net loss or net profit is calculated using the following formula:
Net loss (or net profit) = Revenues – Expenses
Since income and expenses balance each other in a given period, the net loss is an example of the matching principle, which is an essential part of accrual accounting. Expenses related to income earned in a given period are included (or allocated) in that period, regardless of when the expenses are paid.
Factors Contributing to a Net Loss
- The most common factor contributing to a net loss is a low revenue stream. Strong competition, unsuccessful marketing programmes, weak pricing strategies, failure to adapt to market demand and inefficient marketing personnel are all factors that contribute to a decrease in revenue. Falling revenues lead to falling profits. When profits fall below the level of expenses and cost of goods sold (COGS) in a given period, a net loss occurs.
- The cost of goods sold also affects the net loss. The significant costs of producing or purchasing the goods sold are deducted from revenue. The remaining money is used to cover expenses and generate profits. If production costs exceed the financing of expenses, a net loss occurs.
- Expenses also contribute to the net loss. Even if expected revenues are achieved and the cost of sales remains within budget, unforeseen expenses and overspending in budgeted areas can exceed gross profit.
- One type of expense that can contribute to net losses is excess accounting costs. This is the cost that a company pays to keep inventory in stock before it is sold to customers.
Net Loss Examples
Suppose that significant refunds have been provided, as companies have taken advantage of outstanding tax credits, previously granted as a means of preserving jobs in the state during the recession. As a result, the State Treasurer expects a $99 million decrease in revenue from major corporate taxes. This causes state officials to reduce revenue forecasts for the current and next fiscal year by a significant amount, and if they fail to cut spending as well, they will suffer a net loss.
Another example would be Company A with $200,000 in revenue, $140,000 in cost of sales, and $80,000 in expenses. If you subtract the $140,000 in COGS from the $200,000 in sales, you get a gross profit of $60,000. However, since the expenses exceed the gross profit, the net loss is $20,000.
Another example would be a company that sells frozen food and has to pay for cold storage, procurement costs, taxes, labour costs and insurance. If sales are slow, the company has to hold inventory longer, incurring additional accounting costs that may contribute to the net loss.
Can a company with positive revenues still have a net loss?
Yes, even if a company has high revenues, it can still make a loss if the cost of goods or other expenses associated with those sales (e.g., marketing) are too high. Other factors, such as taxes, interest expenses, depreciation and one-off costs, such as litigation, can also turn a company from a profit to a net loss.
What is a net operating loss carryforward?
The US IRS allows certain net losses incurred in one tax period to be deducted from net profits earned in subsequent periods. The Tax Cuts and Jobs Act (TCJA) of 2018 changed the way businesses must recognise net operating loss carryforwards. Consult your accountant for all tax questions
Is a net loss equivalent to a negative gain?
Technically, there is no such thing as a negative gain, since a gain by definition implies an increase in value. However, the term ‘negative gain’ is colloquially used to describe a net loss.