What Is an Operating Loss (OL)?
An operating loss occurs when a company's operating expenses exceed gross profits (or revenues in the case of a service-oriented company). A company's operating profit is its profit before interest and taxes. Interest and taxes are not considered operating expenses in the way that cost of goods sold, selling, general and administrative expenses are. Often companies generate enough revenue to cover the operating expenses and make an operating profit.
An operating loss does not consider the effects of interest income, interest expense, extraordinary gains or losses, or income or losses from equity investments or taxes. These items are "below the line," meaning they are added or subtracted after the operating loss (or income, if positive) to arrive at net income.
If there is an operating loss, there is usually a net income loss unless an extraordinary gain (e.g., sale of an asset) was recorded during the accounting period.
Key Takeaways:
- If a company's operating expenses exceed their gross profits, it will show an operating loss on the financial statements.
- An operating loss excludes the effect of interest income, interest expense, extraordinary gains or losses, or income or losses from equity investments or taxes.
- An operating loss reflects unprofitable operations, and changes may be required to decrease costs or increase revenues.
- A company might also experience an operating loss if it is re-investing in itself to expand business in the future.
Understanding Operating Losses
An operating loss indicates that a company's core operations are not profitable and that changes need to be made to increaserevenues, decrease costs, or both. The immediate solution is typically to cut back on expenses, as this is within the control of company management. Layoffs, office or plant closings, or reductions in marketing spending are ways to reduce expenses. An operating loss is expected for start-up companies that mostly incur high expenses (with little or no revenues) as they attempt to grow quickly.
In most other situations, if sustained, an operating loss is a sign of deteriorating fundamentals of a company's products or services. However, that's not necessarily the case if a company is spending more money in the short-term to hire additional employees, conduct a fresh sales and marketing campaign, or lease extra office space in anticipation of expanded future business. In such a scenario, a company may be hit with a few or several quarters of operating losses until the bump-up of the expenditures declines and the benefits of the added spending manifest in the top line.
Real World Example of Operating Loss
For a company that manufactures products, gross profit is sales less the cost of goods sold (COGS). In 2009, the year that the Great Recession took hold, Huntsman Corporation recorded an operating loss of over $71 million. That year gross profit was $1,068 million, while operating expenses composed of selling, general, and administration (SG&A), research and development (R&D), restructuring, impairment, and plant closing costs totaled $1,139 million, leaving the chemical maker with an operating loss. The last expense line item was $152 million in charges. Such expenses, in most cases, are considered non-recurring, which means that a normalized operating income/loss number would exclude the charge. Instead of the operating loss, an "adjusted" result would be an operating profit of $81 million.
