Douglas has two master's degrees (MPA & MBA) and a PhD in Higher Education Administration.
Business owners hope that each period, the money brought in is more than the money paid out. But that's not always the case. In this lesson, you'll learn the definition and formula for net loss, and why it can be bad news for business owners.
What Is Net Loss?
An income statement is a financial report that takes the total of revenues and expenses for a certain period of time and calculates the bottom line. Ideally, the bottom line is positive, meaning that the business had more revenue than expenses, but at some point, most businesses experience the opposite - a period of time where the total of all expenses and costs exceed the revenues earned. When that happens, the business has suffered a net loss.
For all practical purposes, there is no difference between a 'net' loss and just a loss. Because generally-accepted accounting principles (or GAAP) in the United States require an income statement to report gross profit and net profit, the term 'net' sticks around to accompany the loss, in the (hopefully) rare instances a net loss does occur.
Formula for Net Loss
The formula for net loss is simply:
Total Revenue - Total Expenses = Net Profit or Loss
It is important to remember that based on the matching principle of accounting, the total revenues and total expenses used in the net profit/loss formula represent the same period of time. For example, if a business owner requests their accountant prepare quarterly financial statements, then the income statement for the first quarter of the year (January through March) will include all revenues earned in that quarter and all expenses earned in that same quarter.
Example of Net Loss
For the sake of simplicity, let's take a look at the monthly revenues and expenses for Patty's novelty t-shirt printer 'Tee It Up!' Patty purchases t-shirts in bulk, prints the designs customers submit, and sends the shirts out for delivery. Through Patty's website, customers can select the type of shirt and size, and can upload their design.
Patty runs the whole show herself, but to make sure she knows it is a profitable venture, she pays herself a salary of $5,000 per quarter. Below is Patty's income statement, sometimes called a profit and loss statement, for the first quarter of 2013.
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So, in this quarter, Patty had a net loss of $2,200. On financial statements, negative amounts are indicated by being shown in parentheses instead of the negative sign. Patty's example is used to make another point about net losses. Financial statements, while subject to certain generally-accepted principles, are not generated using very strict, meticulous calculations. Imagine Patty was going to try and get a loan to fund some growth. She wouldn't want to show a net loss, so she could take off the $5,000 that she paid herself and then show a $2,800 net profit.
The more complex the company, the more complex their financial statements and the more room there is for subjective judgments in how and what to include. Understanding financial statements is a whole other lesson, but the point to remember here is that it's important to understand how someone calculates a net loss, not just what that net loss is.
While the definition of net loss, the amount of money lost during a stated period of time, is simple, the implications are important to understand. Likewise, the formula for net loss, total revenues less total expenses, also seems straightforward, but there is an entire profession and government agency with the expressed purpose of setting standards and principles for calculating that formula. Thankfully, not everyone needs to know them all. Just remember, you don't want to lose money, but you want to understand what it means if you do.
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