Operating at a Net Loss?

Here are a few matters to consider

Firstly, What is a Net Loss (or Negative Net Income)?

Investopedia says, “A Net loss indicates that a company's core operations are not profitable and that changes need to be made…In most other situations, a net loss is a sign of deteriorating fundamentals of a company's products or services if sustained.”

Finance and accountants know that net losses are incurred when the expenses in relation to running a business, such as wages and salaries and working capital charges, exceed the revenue it earns.

When net losses occur, firms must either increase revenue or decrease expenses.

Secondly, ask yourself, how did you get here?

For a loss to happen, it should have been expected or budgeted for by the finance department because, quite frankly, stakeholders do not like net loss surprises at the end of a reporting period.

(Tip: An expected loss may occur when a company is in the start-up phase or may substitute its losses in the short term to incur profits in the long term, such as through investments in research and development.)

Another way to consider why a net loss is so far-reaching for the CFO is to look at it from the balance sheet point of view. When a company has a net loss, its retained earnings and, therefore, shareholder’s equity will decrease due to the accounting treatment of a loss.

Since a balance sheet, in theory, must balance, assets must decrease, or liabilities must increase to offset the net loss because losses are always ‘financed’ in a period (Assets – Liabilities = Capital).

When losses become second nature to a firm or are sustained, corporate failure may result because assets are reducing and debt or liabilities are increasing. This then affects the company's marketability because dividends cannot be paid, and shareholders prefer long-term growth and returns.

Lastly, What can you do?

While this list is not meant to be exhaustive, here are a few ways net losses can be managed.

1. Support Strategic Plans. When net losses are serious, the right finance leader is necessary to turn things around. A plan must then be constructed that can range anywhere from a review of profitable or nonprofitable divisions to re-financing through debt or equity. This collaborative exercise involves multiple departments, such as sales and production.  Sales may have to sell more, and production may have to make more. Updated costs of existing products and product design features become questionable to ensure higher margins are made so that the company can achieve higher revenue. (Tip: To increase revenue, one must always know two things: the item that consumers love and buy the most and the cost to produce the product to set accurate or higher selling prices then)

2. Depreciation. Where Property, plant, and equipment, or fixed assets are significant or highly material on a firm’s balance sheet, then a review of the depreciation rates should be done from time to time. Why? Because the review should help to ensure the depreciation rates are in line with group policy or benchmarks. A lower rate may be more appropriate if the depreciation rate is higher than its benchmarks or other firms in its industry. A lower, more realistic rate aligned with benchmarks might signify less depreciation and, therefore, less expense.

3. Labour. Companies do not just pay salaries and wages. They also have to pay employment insurance and make pension contributions. When an economy experiences a windfall, these expenses may increase, which puts pressure on firms and employees. While this is a very controversial line item, in my experience, this is the line that many firms use to reduce drastic expenses because it is usually the most expensive line item on an income statement.

4. Other. If you work in finance, this may take the form of applying for available grant funding on projects to cover expenses or an all-out review or cuts to departmental and general expenses.

Losses need to be managed if your firm is operating at a loss.

What will you add?

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