Net Loss: Definition, Formula, and Examples
What Is Net Loss?
A net loss occurs when total expenses (including taxes, fees, interest, and depreciation) exceed income or revenue generated for a given period. Net loss can be compared to net profit, also known as income after tax or net income.
Key Points
A net loss occurs when the total amount of expenses exceeds the total income or revenue generated by a business, project, transaction, or investment.
Companies will report a net loss on the income statement, effectively as a negative net profit.
Many factors can contribute to a net loss, including decreased revenues, strong competition, unsuccessful marketing campaigns, and increased cost of goods sold (COGS).
Understand the Net Loss
For a business, net loss is sometimes called net operating loss (NOL). For tax purposes, net losses can be carried forward to future tax years to offset profits or gains in those years. The net loss appears in the company's bottom line or income statement. Net loss or net profit is calculated by the following equation:
Net Loss (or Net Profit) = Revenues - Expenses
Because revenues and expenses are matched over a period of time, the net loss is an example of the matching principle, which is an integral part of the accrual method of accounting. Expenses (or "equivalent") expenses related to income earned during a given period are included in that period regardless of when the expenses are paid.
Quick Facts:
A net loss occurs when profits over a period of time fall below costs and costs of goods sold (COGS).
Factors Contributing to Net Loss
The most common factor contributing to a net loss is decreased income. Strong competition, unsuccessful marketing programs, poor pricing strategies, failure to meet market demands, and inefficient marketing personnel lead to lower revenues. Lower revenues lead to lower profits. A net loss occurs when profits over a period of time fall below costs and costs of goods sold (COGS).
COGS also affects net losses. Significant production or purchase costs for the product to be sold are deducted from revenue. The remaining amount is used to cover expenses and make a profit. When cost of goods sold exceeds financing expenses, there is a net loss.
Expenses also contribute to net losses. Even when targeted revenues are achieved, and cost of goods sold remains within limits, unexpected costs and overspending in budgeted areas can exceed gross profit.
Excessive carrying costs are one type of expense that can contribute to net losses. These are the costs a company pays to hold inventory in inventory before selling it to customers.
Advice:
Companies that incur a net loss do not necessarily go bankrupt immediately because they may choose to use their retained earnings or debt to stay afloat. However, this is only a short-term strategy, because without profits the company will not be able to survive in the long term.
Examples of Net Loss
However, large refunds were expected because businesses took advantage of previously issued tax credits as a way to keep jobs in the state during the recession. As a result, the state treasurer expects a $99 million decrease in revenue from the state's core business taxes. This is causing state officials to cut revenue estimates for the current and next fiscal years by a significant amount, and unless they can also cut spending, they will be operating at a net loss.
Another example is if Company A has $200,000 in sales, $140,000 in cost of goods sold, and $80,000 in expenses. Subtracting $140,000 in cost of goods sold from $200,000 in sales results in a total profit of $60,000. However, since expenses exceed gross profit, there is a net loss of $20,000.
Another example is a company that sells frozen foods and needs to pay for cold storage facilities, utility costs, taxes, employee costs, and insurance. If sales are slow, the company will need to hold its inventory longer, incurring additional costs that may contribute to a net loss.
Can a company with positive earnings incur a net loss?
Yes, even if a company's sales volume is high, it can still make a loss if its cost of goods sold or other costs associated with those sales (such as marketing) are high. Other factors such as taxes, interest expenses, depreciation and amortization, and one-time charges such as lawsuits can shift a company from a profit to a net loss.
What is net loss carryforward?
The IRS allows certain net losses incurred in one tax period to be used as a deduction against net gains earned in subsequent periods. The Tax Cuts and Jobs Act of 2018 (TCJA) changed the way businesses must calculate net operating losses. Consult your accountant for all tax matters.
Does net loss equal negative profit?
Negative earnings technically do not exist, because earnings by definition mean an increase in value. However, the term negative profit is colloquially used to describe net loss.
