Net Loss Definition

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What Is Net Loss?

A net loss is when total expenses (including taxes, fees, interest, and depreciation) exceed the income or revenue produced for a given period of time. A net loss may be contrasted with a net profit, also known as after-tax income or net income.

Key Takeaways

  • A net loss occurs when the sum total of expenses exceeds the total income or revenue generated by a business, project, transaction, or investment.
  • Businesses would report a net loss on the income statement, effectively as a negative net profit.
  • Many factors can contribute to a net loss including low revenues, strong competition, unsuccessful marketing campaigns, and increased cost of goods sold (COGS). 

Understanding Net Loss

For a business, net loss is sometimes referred to as a net operating loss (NOL). For tax purposes, net losses may be carried forward into future tax years to offset gains or profits in those years. A net loss appears on the company’s bottom line or income statement. Net loss or net profit is calculated using the following formula:

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Net Loss (or Net Profit) = Revenues – Expenses

Because revenues and expenses are matched during a set time, a net loss is an example of the matching principle, which is an integral part of the accrual accounting method. Expenses related to income earned during a set time are included in (or “matched to”) that period regardless of when the expenses are paid.

When profits fall below the level of expenses and cost of goods sold (COGS) in a given time, a net loss results.

Factors Contributing to a Net Loss

  • The most common factor that contributes to a net loss is a low revenue stream. Strong competition, unsuccessful marketing programs, weak pricing strategies, not keeping up with market demands, and inefficient marketing staff contribute to decreasing revenues. Decreased revenues result in decreased profits. When profits fall below the level of expenses and cost of goods sold (COGS) in a given time, a net loss results.
  • COGS also affects net losses. Substantial production or purchase costs of products being sold are subtracted from revenue. The remaining money is used for covering expenses and creating profit. When COGS exceeds funding for expenses, a net loss occurs.
  • Expenses contribute to net losses as well. Even when targeted revenue is earned, and COGS remains within limits, unexpected expenses and overspending in budgeted areas may exceed gross profits.
  • Excessive carrying costs are a type of expense that can contribute to net losses. These are the costs a company pays for holding inventory in stock before it is sold to customers.

Businesses that have a net loss do not necessarily go bankrupt immediately because they may opt to use their retained earnings or loans to stay afloat. This strategy, however, is only short-term, as a company without profits will not survive in the long-term.

Net Loss Examples

Say that substantial refunds were expected as companies took advantage of outstanding tax credits previously issued as a way of retaining jobs in the state during the recession. As a result, the state treasurer anticipates a decrease of $99 million in revenue from the state’s principal business taxes. This prompts state officials to cut the current and upcoming fiscal year revenue projections by a significant amount and, unless they can cut expenditures as well, they will be operating at a net loss.

Another example would be if Company A has $200,000 in sales, $140,000 in COGS, and $80,000 in expenses. Subtracting $140,000 COGS from $200,000 in sales results in $60,000 in gross profit. However, because expenses exceed gross profit, a $20,000 net loss results.

Yet another example would be of a company that sells frozen foods and needs to pay for refrigerated storage facilities, utility costs, taxes, employee expenses, and insurance. If sales are slow, the company will need to hold onto its inventory for a longer time, incurring additional carrying costs which could contribute to a net loss.

Can a company with positive revenues still have a net loss?

Yes, even if a company has a large volume of sales, it can still end up losing money if the cost of goods or other expenses related to those sales (e.g., marketing) are too high. Other factors like taxes, interest expenses, depreciation and amortization, and one-time charges like a lawsuit can also take a company from a profit to a net loss.

What is a net loss carryforward?

The IRS allows certain net losses experienced in one tax period to be used to deduct from net profits earned in subsequent periods. The 2018 Tax Cuts and Jobs Act (TCJA) changed how businesses must account for net operating loss carryforwards. Check with your accountant for all tax matters

Is a net loss the same as a negative profit?

A negative profit technically does not exist, since a profit, by definition, implies a gain in value. However, the term negative profit is used colloquially to describe a net loss.

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View more information: https://www.investopedia.com/terms/n/netloss.asp

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