What Is Net Loss? Definition, How To Calculate It and Causes
By Desmond Motiso
Updated October 17, 2022 | Published February 25, 2020
Updated October 17, 2022
Published February 25, 2020
Desmond Motiso is a creative, cross-functional, tech-savvy and Cisco-certified digital copywriter with 5+ years of professional experience in producing content free of technical jargon. He enjoys finding unique angles to stories and creating evergreen content that provides value, engages and informs both technical and non-technical audiences.
If you work with financial statements or reports, it's essential to understand the concept of net loss. This accounting term involves using multiple components to discover valuable information about a company. Learning about net loss can help you interpret it on a financial statement, understand factors that may lead to it and help a business make more profitable decisions.
In this article, we define net loss explain why it's important to calculate it and how to do so, share which factors lead to net loss and how to record it on financial statements, then give examples of it.
What is net loss?
Net loss, or net operating loss, is when an organization's total expenses exceed its total income or revenue for a specific period. Net loss is the opposite of net income, in which income or revenue exceeds expenses and results in a profit. Companies can expect or plan for a short-term net loss in response to various economic factors, and a business may use the earnings it retains to continue operating. Net loss also differs from gross loss, which is the negative amount left after subtracting the cost of goods sold from total revenues.
Net loss includes the revenues and expenses for a specific period. The accrual method of accounting records expenses and income when companies incur them, regardless of when they pay for expenses. Several factors can contribute to a net loss, but they all relate to a decrease in revenues or an increase in expenses. For example, payroll for work in December 2022 may not receive pay until January 2023. Since the expenses match December 2022 revenues, they appear on the 2022 financial statements.
Why is calculating net loss important?
It's essential to accurately calculate and report net loss on financial statements because it determines a company's taxable income. It can qualify a business for tax refunds, which a company can use to fund new marketing campaigns, develop new products or increase inventory. Net losses show on a company's income statement and statement of equity. If you're a potential investor in a company, a concurrent net loss might be a sign to proceed with caution.
Related: What Is a Marketing Campaign?
Calculating net loss
The formula for calculating net loss is revenue minus expenses equals net loss or net profit. Here's its formula:
Net profit/loss = total revenue or income - total expenses
Here's a step-by-step guide for calculating net loss:
Calculate revenue. First, determine the revenue, which is the income the business generates. If net income and net loss are the bottom line of a financial statement, then revenue is the top line.
Identify expenses. Calculate the total sum of all expenses to evaluate how much it costs to operate the business. These include fixed costs, which the company pays regularly, and variable costs, which may change depending on several factors.
Subtract expenses from the revenue. If the calculation yields a negative number, that number is the net loss, which represents how much money the business lost for that period. If the calculation yields a positive number, that number represents the net profit.
Factors that lead to a net loss
Here are some factors that can cause a business to earn a lower revenue than it expected to, which can cause a net loss:
Declining sales or increasing market competition
When a competitor takes away customers or clients, revenue decreases and leads to a net loss. This may result from customer preference toward a competitor's products, improvement in marketing strategies or lower product prices. For example, a competitor might come into the market and provide a higher quality product or affordable service. In that situation, customers may switch to that company's product or service, resulting in lower sales and net losses.
Decreasing effectiveness of marketing campaigns
Marketing campaigns may contribute to a net loss if they don't yield the results a company expects. When a company spends money on advertising, it often expects the campaign to bring in enough revenue to cover expenses and contribute to the profit. If that doesn't happen, it can lead to a net loss.
Rising variable costs
An increased cost of goods sold also can contribute to a net loss. When the expenses to produce an item or service rise, the market may have a corresponding price increase. For example, if companies experience higher variable costs, such as raw material and storage costs, they may compensate by increasing product prices, leading to fewer sales.
Increasing carrying costs
Carrying costs are the expenses a company incurs by keeping inventory in stock. For example, a company may pay for a specific type of storage, such as refrigeration or heating. The business also might pay for additional insurance for the items in storage. If the products aren't selling as fast as usual, those carrying costs increase and can create a net loss. Whatever the reason for the change, when companies receive less income than they expect, even if expenses remain the same, the result is a net loss.
How to record a net loss on financial statements
Follow these steps to record a net loss on quarterly or annual financial reports:
Review the general ledger. Identify accounts with a debit balance, such as assets and dividends. Then, you can determine which accounts have a credit balance, such as liability and revenues.
Record balances. You can place each debit balance in the left column of an adjusted trial balance form. Each credit balance goes in the right column.
Sum each column. Next, you add the debit column, then add the credit column. If both values don't match, look for errors in the ledger accounts.
Add the credit balances. Finding the sum of the revenue account balances determines total revenue.
Add debit balances. The sum of the expense account balances is the company's total expenses.
Subtract the total expenses from the total revenue. If the expenses are higher than the income, this calculation yields a negative number, which is the net loss.
Net loss examples
Here are two examples of business situations that may lead to a net loss:
Calculating net loss using income and expenses example
This example can help you understand how to calculate net loss from income and expenses:
A company has an income of $100,000 for the calendar year 2021. The total of all the expenses of running the business is $120,000. The business can calculate its net less with this formula:
Net loss = $100,000 - $120,000
This means the company experienced a net loss of $20,000 in 2021.
Using earnings to cover net loss example
Here's an example of how a company can use earnings to cover losses:
A small business incurs a net loss for the year to buy out a competitor. The purchase increases the expenses by $100,000. Revenues for the same period are $75,000 more than expected. The company uses the net loss formula to determine how much retained earnings it needs to use to cover its shortages:
Net loss = $75,000 - $100,000
This expense creates a net loss of $25,000, so the operations management team uses $25,000 in retained earnings to help the company break even.
This article is for informational purposes only and does not constitute financial advice. Consult with a licensed financial professional for any issues you may be experiencing.
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