What Is An Operating Loss?
Operating Loss can be defined as a loss that occurs when the operating expenses of a company are greater than its gross profits or gross income. Operating profit is the profit that a company earns before calculating its taxes and interests. The income statement of a company indicates whether the business has incurred an operating profit or loss. Operating loss suggests that the company is unable to generate enough revenue from its operations to pay interests and dividends. The fixed costs that a company incurs while conducting business have the strongest influence on the operating expenses. When the company incurs an operating loss, it implies that the revenue being generated is not enough to cover all the fixed costs and the company needs to either increase its sale or lower its costs.
How to Calculate Operating Loss?
The operating cost of a company includes all the expenses that are incurred in the revenue-generating activities. It includes all the fixed costs (overheads, machinery, security, administrative expenses), variable costs (raw material, electricity, labor), and semi-variable costs (overtime wages).
Operating cost can be calculated by the cost of goods sold (COGS) and the operating expenses (OPEX). The cost of goods sold includes all the fixed and variable costs incurred in the production and sale of those goods. The operating expenses include all the other business operations that are not directly included in the cost of goods sold. It includes rent, machinery, insurance, security, advertising, marketing, inventory cost, research, and development.
When the cost of goods sold and operating expenses are added, it amounts to the total operating cost incurred by the company. Operating cost does not include any taxes, interests, or capital expenses.
Significance of Calculating Operating Loss
It is important to know the total operating costs being incurred in the business operations of a company. It is an important number that ensures the success of a business and also indicates the profitability of the business to investors. It is significantly important in the following ways:
- The Operating cost of a company indicates the expenses it incurs in the production and sale of its goods. If the company is constantly facing losses in its operating income, it means it is not generating enough revenue to cover the fixed cost of production. It is a strong indication of either increasing the sales or reducing the fixed cost of production.
- It is an important number that indicates the profitability of a company’s business operations. When an investor is willing to invest in a company, the income statement of the company is assessed to check whether it is incurring a profit or loss. Operating loss indicates that the company is unable to generate enough revenue to pay its interests and dividends.
- Operating costs also help in making better decisions for the business on a long-term basis. If a business has consistently incurred losses during a period, reviewing the operating cost can help identify any unnecessary expenses and reduce the cost of production per item.
Examples Of Operating Loss
The cost of goods sold (COGS) includes direct expenses of raw materials and labor, wages and salaries, rent of the production house, repair costs, and utility costs. The operating expenses include all the selling, general, and administrative costs such as cost of equipment, inventory costs, advertising, marketing, insurance, and research and development. The company’s fixed costs and administrative costs do not change with an increase in the production units. Therefore, the company needs to generate more sales to lower its per-unit cost. These expenses can only be identified if a company calculates its operating costs accurately and reviews the numbers regularly.
Operating loss is incurred by a company when the gross profit or gross income is less than its operating expenses and is unable to generate income after paying all the taxes and interest. Operating cost can be calculated by adding the cost of goods sold (COGS) and the operating expenses (OPEX). The net income statement that indicates whether the company has incurred an operating loss or profit is very important to be reviewed and assessed. The operating cost helps a company identify its expenses, lower its per-unit fixed costs and generate more revenue to increase profitability.
Operating loss can be calculated by deducting the operating cost and tax to be paid by the company from the gross income. If the figure is negative, it suggests that the company is incurring an operating loss.
When a company is incurring an operating loss, it is usually because of high fixed and administrative costs. These costs remain the same at all levels of production and can only be reduced per unit by generating more sales. All other expenses are variable and depend upon the units of products being manufactured and sold. Thus, to reduce operating expenses, fixed costs per unit must be reduced.