Net loss refers to the loss incurred by the business during the particular accounting period after considering all the income and expenses incurred by the company during that period and such a situation arises in the company when the total expenses of the company are greater than its total income.
What is Net Loss?
If a business incurs expenses in excess of revenues earned in a specific time period, the loss incurred as a result is known as net loss in the accounting parlance. If the revenues earned are in excess of total expenses, it would result in net profits. In a basic form, loss or profit can be calculated thus:
Loss or net profit is usually recorded at the bottom of an income statement. A business can survive despite incurring net losses by relying on revenues earned during an earlier period or with the help of loans but it goes without saying that the purpose of a business is to turn profits eventually.
Explanation of Net Loss
It is also considered an example of the matching principle as revenues earned in a period and the expenses made against it are matched for that period irrespective of when those expenses might actually be paid. If some of the expenses incurred in a specific period are not paid within that period they are known as accrued expenses.
Understanding Total Expenses
Total expenses can further be broken up in Cost of Goods Sold (COGS) and operating expenses of all kinds which are necessary to keep a business in operation. COGS is the basic figure which must be covered in revenues and if for some reason, including increased costs of production, manufacturing issues, expensive equipment or other factors, revenues might be exceeded by COGS, thus resulting in losses. Assuming COGS is covered by revenues, there can always be an unexpected rise in expenses due to a number of reasons and or increase in spending on areas previously budgeted. All of these factors can add to total expenses and should they exceed revenues, the net loss might result for a specific period.
Causes and Impact of Net Losses
Although it is not unusual for a business to suffer losses, continuing losses would result in lowered accrued earnings and could necessitate extreme measures to cut down on operational or other expenses which could include reducing the manpower or shutting down some of the manufacturing units or downgrading part of the operations none of which would do well in terms of creating a positive image for the corporation in their consumers or investors. Still, at times such drastic measures may help tide over a, particularly difficult period before a business can generate profits again.
Along with these reasons, revenues can also fall below expenses and cost of goods sold due to strong competition or ill-conceived pricing strategies apart from an unsuccessful approach to marketing the products or services offered. Successful marketing programs are often considered the best method for boosting sales and image of a business, resulting in net income which would also be used as accrued earnings for future quarters and support business operations in case net losses result due to some unforeseen reason.
Examples of Net Loss
Company ABC might earn revenues worth $150,000 in a specific period and COGS are $100,000 while expenses mount up to $60,000 against the revenues earned.
Formula for Calculating Net Loss or Profit
Now we can calculate Net Loss as per below:
Total Revenues ($150,000) – Total Expenses (COGS($100,000) + Expenses ($60,000)) =
$150,000 – ($100,000 + 60,000) = $150,000 – $160,000 = -$10,000
Thus, we are left with negative cash of $10,000 after deducting the COGS and expenses from total revenues earned for that period. In other words, Company ABC registered a loss of $10,000 for the said period and would need to rely on accrued earnings or additional resources to stay afloat and carry on with future operations. This happened due to excess of expenses which, along with COGS exceeded the total earnings for the said period.
How Net Losses Influence Taxable Income?
It must also be understood that losses might affect how a company files its taxes due to the way it can alter taxable income in a specific period. Due to regional laws for offsetting losses against income in another period, taxable income might be brought down and businesses could receive tax refunds which would help them keep their operations afloat. However, as already stressed, continued losses would eat into the cash reserves and a business might risk shutting down its operations if it fails to turn things around and generate profits.
Also, have a look at Net Operating Loss
How Net Loss is Different from Gross Loss?
Net loss must also not be confused with Gross Loss which is the negative cash left after COGS is deducted from total revenues. If the result is in positive, it would be termed as Gross Profit and if the result is negative it would be termed as Gross Loss for that period.
Whereas while calculating Net Losses one must deduct COGS as well as all other operational expenses from revenues earned in a period. This is why a company might earn a gross profit for a period which is arrived at simply by deducting COGS from revenues but still end up with Losses when expenses are also taken away from these Gross Profits. If Gross Losses are registered, then Losses would always be higher than Gross Losses for the same reason of deducting expenses as well.
Net Loss is not just another accounting term but an important indicator of how well a business is performing and is called as the ‘bottom line’ both practically, because it is mentioned at the bottom of the income statement, and also figuratively because of its significance in that no matter what odds a business might be facing but if it succeeds in generating profits, things are still looking up and vice versa.
However, it goes without saying that it must not be seen in isolation because a number of times net losses are registered simply as a result of some temporary or transitory change in business operations or production facilities, which must not be considered a cause of concern for the future success of the business. It is only when continual losses are occurring due to inefficient marketing, sub-quality products or very expensive production along with other issues that a business must take necessary actions to turn things around to survive and prosper.
Net Loss Video
This has been a guide to what is Net Loss Income? Here we understand the causes and impact of such Losses along with practical examples. We also discuss how Net loss affects taxable income. You may learn more about accounting basics from the following articles –
- Cash Reserve Ratio Formula
- Limitation of Accrued Expenses on Balance Sheet
- Disadvantages of Operating Income
- Advantages of Accrued Expense Journal Entry
- Examples of Gross Profit and Ratio
- Cost of Goods Sold Formula
- Gross Income vs Net Income
- Operating Profit Margin Formula
- EBITDA vs Operating Income
- Extraordinary Items