A question that I often hear business owners ponder is why their CPAs do not always frown when the bottom line at the end of the year shows a net loss versus a new profit. No one wants to see negative totals his or her financial books as they are a sign that the business spent more on running the business than it did on the returns from operations.
To be sure we are all on the same page, let’s define net profit and net loss.
Net Income = Revenue (sales) – Expenses
When net income is positive, it is called a Net Profit. When the net income is negative, it is called a Net Loss.
The reasons for desiring a net profit are many, for example it shows the business has an “on-going” status, that is, it is moving in the right direction, which is important to a company’s stakeholders. A net profit is also a plus when a business is applying for loans and advancements from third parties. Net profit attracts investors who direct funds into a business which help it grow. These are just some of the reasons a business aims to make a profit.
Net Losses: Tax Benefit
We have seen some of the reasons why businesses strive to make net profits. Are there any benefits that can come out of a net loss? The main business benefit a net loss provides is tax related. In most cases, when a business’s tax year ends in a loss, the business will not owe income taxes. Additionally, the losses can be carried forward and used against future net profits to offset the tax liability. Hence, while it is true that a net loss can limit a business’s borrowing power and make it look unfavorable to potential investors, it can allow a small business to reap tax benefits now and in the future.
Profit vs Loss – Which Should My Business Aim For?
Every business should strive to make money, which is the main reason why it is in business; with the exception of not-for-profits. However, if your business is well established, has a healthy cash surplus, has no current or future plans to borrow funds, then it may make strategic tax planning sense to move your needle as close to a net loss as possible.
There are several ways you can do this. For example, make generous charitable deductions, give handsome bonuses to employees, make financial investments, and purchase year-end non-inventory materials for the start of the new year. It is important to remember that these strategic outsourcing avenues need to happen by December 31st of the calendar year, with the exception of contributions to retirement plans like 401Ks which can be made through April 15th of the following calendar year and reported as expenses in the current tax year. As with any accounting decision, please consult with your CPA to ensure that your unique situation receives accurate advice.
DISCLAIMER: The information provided herein does not constitute the provision of legal advice, tax advice, accounting services, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional legal, tax, accounting, or other professional advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation and for your particular state(s) of operation.
