What is Net Loss?
Net loss is defined as the amount that signifies loss earned by the business once all the expenses are accounted for and deducted from the generated revenue of the company. Therefore, it means a negative value in net income, generally described as a negative term. Such a situation typically arises when the overall expenses incurred by the business normally exceed the revenues generated by the company for the same fiscal or financial year.
The net loss is the negative value of the income line item in the income statement. The management can access this metric in the income statement’s bottom line. To catch this bottom-line metric, the analyst and the stakeholders need to access the income or profit/loss statements. An income statement is a financial statement that broadly consists of revenues earned and expenses incurred by the business. The analyst needs to analyze whether the overall payments and gains made by the company are below or above the total value of the cost of goods sold, losses, income taxes, and operating expenses. The revenues and expenses should be aligned with the matching principle when taking up one financial year.
As per the matching principle, the business has to call out all expenses for the same accounting period for which the company generates revenues. Therefore, it should not relate to the costs incurred in the prior period or be incurred in the coming duration. The matching principle is one of the most critical concepts in accounting that advocates for matching revenues with the expenses for a given financial period, wherein the financial period is also regarded as the financial year ending or fiscal period.
The formula for Net Loss
The revenues earned by the business and the expenses incurred by the company during the business form part of the formula for determining the net loss. The industry tends to make a net loss whenever the costs exceed the revenues the business generates. Therefore, mathematically, the formula for net loss would be expressed as displayed below: –
Net loss = Revenues – Cost of Goods Sold – Operating Expenses – Income Taxes – Any Other Loss
Where revenues< the total cost of goods sold, operating expenses, losses, and income taxes.
Examples of Net Loss
Let us take the example of ABC company. The business reported a revenue of $9,000. The business incurred $4,000 as the cost of goods sold and $3,000 as operating expenses. The business additionally paid $2,500 in income taxes. Determine the net loss as generated by the company.
It is calculated as
Net loss = Revenues – Cost of Goods Sold – Operating Expenses – Income Taxes
- Net Loss = $9,000 – $4,000 – $3,000 -$2,500
- Net Loss = $5,000 – $3,000 – $2,500
- Net Loss = $2,000 – $2,500
- Net loss = -$500
Therefore, the business has incurred a net loss of -$500. The following is that displays the computation of net loss: –
|Cost of goods sold (B)||$4,000|
|Gross profit (C) = (A-B)||$5,000|
|Operating expenses (D)||$3,000|
|EBIT ( E ) = (C-D)||$2,000|
|Net loss (G) = (E-F)||-$500|
What is Included in Net Loss?
It generally comprises revenues, cost of goods sold, operating expenses, and the income taxes, if any, on the income and any potential loss suffered by the business. It also comprises values that are indicators of weak pricing strategies of the company or not being aligned with the market, stiff competition, and unsuccessful marketing campaigns. Additionally, net losses indicate that the business has incorporated weak marketing strategies.
How to Record Net Loss?
It is recorded using the concept of the matching principle. As per the matching principle, the expenses incurred during the financial year must match and relate to the revenues earned by the business for the same accounting period, financial year, or fiscal period. The expenses are to be recorded whether they are paid off or not. The costs that are not paid but recorded are generally termed accrued expenses. Generally, lower revenues generated by the business contribute to incurring net losses to the company.
Importance of Net Loss
It is a very crucial metric. It is the indicator of the profitability and financial position of the business for a given financial year. However, it is generally not identified as a favorable metric for a business. The metric can be used by internal stakeholders, debtholders, and investors to determine whether they should invest in the industry. Generally, suppose the company is producing consistent net losses throughout the year. In that case, the stakeholders shouldn’t invest in such a business, and the management should look toward the winding up of the company.
Some of the advantages are given below:
- It helps the management to become cautious over the impending weak financial position of the business.
- The management may adopt a conservative approach that helps curb the business’s losses.
- It helps internal stakeholders base their decisions on whether they should invest in the business.
Some of the limitations are given below:
- It is the significator of the weak financial position of the business as well as indicates that the company has performed below expectations.
- Consistent reporting of net losses by the business may cause the company to wind up its operations as negative earnings impact the sustainability of the business itself.
It is also regarded as the loss incurred by the business in a situation wherein the company’s financial position is not very healthy, and the total expenses incurred by the business exceed that of total revenues generated by the industry. It generally indicates that the company has suffered a loss in terms of monetary terms during the business for a given financial year. It is determined if the industry applies the matching principle correctly, wherein the revenues earned by the company should match the expenses generated by the business. It can be captured at the bottom line of the income statement.
This is a guide to Net Loss. Here we also discuss the definition and how to record net losses with advantages and limitations. You may also have a look at the following articles to learn more –