Running a business has plenty of learning curves. One of the most important lessons you will have to learn when running a business of your own is understanding business losses. These typically arise from two cases – either normal operational inefficiencies or abnormal events that disrupt the business. Business losses happen in the event that a company doesn’t manage to acquire enough income to adequately cover business operating expenses. For business owners, losses are damaging and should be prevented and avoided at all costs (pun intended).
In the event that a company’s operating expenses are higher than the revenue it generates, the business is considered to be running a loss. What constitutes operating costs? Well, payroll, pension contributions, employee benefits, advertising, travel and compensation, sales commissions, rent, business repairs, and asset depreciation. Typically, operating expenses fall under one of three categories – general expenses, administrative, or selling expenses.
There are cases where a company may experience irregular or unusual economic events that are not actually categorized as an expense but simply as a loss. These are usually one-time occurrences. These events may arise from, for example, the effects of accounting changes. Casualty losses also come in events out of the business owner’s control like hurricanes, earthquakes, and other disasters that result in loss or damage to property and equipment or even casualty of staff. Irregular losses also arise from cases of theft, arson, or unprotected strikes. Companies may deduct the outstanding amounts for losses that insurance did not cover.
This is also known as an income statement, and it is a record of the business’ finances. The statement is a summary of the revenues, costs, and expenses incurred over a specified period of time. The P&L statement is a common business document which allows one to easily see how much profit and loss a company has generated. A balance sheet is a different type of document and does not show the changes in the revenue, costs, and expenses over time as the P&L statement does. Typically, unusual gains or losses are documented separately from the regular operational expenses and revenue of a business. This is done to provide a more accurate image of the business’ financial standing which can otherwise be skewed by irregular occurrences.
Should a business encounter significant loss, it may be eligible for considerable tax deductions. Net operating losses occur when businesses have more allowable tax deductions than taxable income. When the business exhibits a net operating loss, it will be exempt from paying tax for that tax period.
The business type will directly influence the impact that business losses and taxes make on business owners. Owners of corporations are not taxed directly on their business’ profits and losses as the corporation’s taxes are separate from that of its owners who are considered shareholders, so they are only taxed based on the dividends that they are paid out by the business. In the event that there are no dividends, there is no tax to pay. However, for other business types, the profits and losses are passed to the owners and appear on their personal tax returns.
While losses cannot be carried back to other periods of time, there is also no limit on how long you can run your business in spite of running at a loss. Most of the time, business owners run out of money to keep the business going when there is no revenue to cover the operating costs. But if you happen to have the finances in your personal capacity or by other means to maintain the business, nobody can actually stop you. However, continual losses for multiple years in a row does call for more attention from the IRS — you may be able to classify your business as a hobby if there isn’t any advancement towards profits. Of course, this may depend on your business type as well. Losses may also be carried forward to future tax years, and this is advantageous as you are allowed to carry forward up to 20 years in advance, helping you pay a lower tax on the taxable income of the business in the future. Clever stuff!
Now that you understand all about losses in your business, you can move on to learning another of the many lessons yet to come in your entrepreneurial journey!