Have you ever wondered what really happens, when a company makes a loss? Who pays for it? How do loss making companies keep operating? To start, in simple terms – a loss occurs when expenses exceed Sales. You can calculate this on a monthly basis, as is done traditionally when you do the financials. A month or two of losses can be overcome, easily, if in the previous months you have profits. A sustained loss is ultimately unbearable and it starts with the inability to pay bills from your Sales and collections. This usually brings on a forced makeup of a priority list of what to pay – salaries is the first priority, then it is materials or goods for sale, then it could be utilities, rent and so on. The business is now experiencing a severe cash shortage.
At this stage, a business may decide to borrow more money and/or the owners will put in more money. This means you can pay bills that have come due; the company is getting an infusion of new capital. This is only viable if con-currently there is a plan to makes Sales exceed expenses and it can be implemented in a relatively short period of time – certainly before the new infusion of capital runs out. A business has to be self sustaining. !
Sustained losses, produces more liabilities than assets and is called “negative equity” – this means, the owners Capital has been wiped out due to the business losses and the Balance sheet will now show liabilities exceeding assets.