Nobody likes losses of any type. But losses are a part of this life and business. Understanding business losses, their types, magnitude, reach, why/how they occur and knowing what to do about them can help us pre-empt, manage, and/or learn from them to do better in business and life.
What is a business loss? Generally speaking, no longer having something in full or in part in unwanted circumstances, is what we term as a loss. Losses occur in virtually all aspects of our lives. For instance, we could lose some property that we own, our health or a loved one. For our purposes here, however, we will be considering businesses losses only.
A business loss is often said to occur when expenses exceed revenues or when market value of assets falls below their book value. We, definitely, lose in both circumstances. But these definitions of losses are, quite understandably, restricted to what we can measure and ascribe a financial value to. Beyond what we can measure and ascribe financial values to, however, a businessperson needs to spread out the net to be able to understand, see and smell many more types of possible losses. For example, a business may ‘lose’ opportunities to make more money in ways that we cannot measure when a high-flying salesperson suddenly leaves the organisation. The business may lose the patronage of some accounts managed by the departing salesperson who may take those accounts to the next organisation they join. The point is, the mind of the entrepreneur should be more alert and open to events that portend threats to the capacity of the business to make money, regardless of whether the consequences of the events can be financially measured or not.
On the basis of the above, therefore, we may say a business loss occurs within a particular accounting period or may occur in subsequent accounting periods as a result of any event that immediately hurts or may subsequently hurt the business irrespective of whether the loss may be financially measured or not. Understanding losses this way removes the restriction mentioned earlier, thereby making us more alert to the implications of what we do and the happenings around us.
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Let us now try to understand the different types of business losses, financial or not, measurable or not, as well as their possible impacts.
Types of business losses: Understanding the types of business losses that may happen to a business is important because each may be caused by different events and therefore need different handling actions either to pre-empt them before they occur or manage them after they occur.
For accounting purposes, losses may occur due to any or a mix of some of the following:
• Costs incurred that do not produce any benefit
• Decrease in the value of resources
• Excesses of expenses over revenues (for individual transactions and for all transactions over an accounting period)
• Contingent losses as a result of expected and unexpected events
‘Operating losses’ occur when finished products, sell for less than the amount the business spent to produce and/or simply to obtain and make the products available to the market. The total costs in such situation will include both the direct and indirect costs attributable to the production and distribution of the product. Individual transactions may be profitable by producing positive gross profits but the total contribution from all transactions may not be sufficient to cover the selling, general and admin expenses, thereby leading to a net loss on the overall. On the other hand, ‘capital losses’ occur when capital assets, like land and manufacturing equipment are sold for less than their book value. The net book value of such assets is generally taken as the amount invested to acquire them less the depreciation charged over the years they have been in use.
Losses may also be termed as ‘normal’ or ‘abnormal’. A loss is considered ‘normal’ when it cannot be avoided in the ordinary operations of the business. For instance, in conveying a consignment of tomato from Kano to Enugu, some ‘acceptably reasonable’ quantity is likely to be destroyed even with the best of loading and unloading practices. A loss is ‘abnormal’ when it occurs beyond the range of what is ‘normally acceptable’ such as due to outright carelessness in loading and unloading of the vehicle conveying the tomato from Kano to Enugu.
Understanding each type of loss and the appropriate accounting treatment, where possible, is important in tracing its causes, establishing its implications/consequences in the business as well as what can be done to pre-empt or mitigate it.
Impact of losses: Different losses have different impacts on a business. The impact could be in terms of their direct/indirect financial magnitude and/or reach. The magnitude refers to the quantum of their impact in impairing (or potentially impairing) the financial position of the business whilst the reach refers to how wide within the business and how far in time the consequence of the loss may impact the business negatively. The quantum of ‘normal’ losses is usually low, and their reach do not typically go deep when absorbed in the financials. For example, the loss of a few tomato in the loading and unloading may easily be absorbed by the same consignment/transaction and a gross profit is still declared. Abnormal losses, on the other hand, may or not be large in quantum and may or may not be wide and deep in reach. For instance, a fire incidence may be quickly and effectively contained that the damage done to the business is minimal and shallow. However, it could also be widespread, consuming both working and capital assets thereby not only hampering current operations but, in addition, hurting the near-term operational capacity of the business.
It is important for the entrepreneur to understand the types and dynamics of different business losses for their business success and personal emotional management. Next week we will take up specific types of losses and what the entrepreneur can do about them.
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