What Is an Operating Loss and How Is It Calculated?

An operating loss is a financial measure that reflects a company’s inability to cover the costs of its primary business activities with its revenue. It serves as an indicator of the profitability of a company’s core operational functions, separate from any financial or investment-related gains or losses. An operating loss signals that main revenue streams are insufficient to pay for day-to-day expenses.

An operating loss provides a view of the underlying health of the business and suggests its model may be under pressure, requiring management to either increase sales or reduce costs. For new or rapidly growing companies, an operating loss can be expected as they invest in building their market presence. For established companies, however, a persistent operating loss can be a sign of operational inefficiency or declining market demand.

Calculating an Operating Loss

The calculation of an operating loss is derived from a company’s income statement. It begins with operating revenue, which is all income generated from its principal business activities. From this revenue, two main categories of costs are subtracted to determine the operating result.

The first deduction is the Cost of Goods Sold (COGS), which represents the direct costs of producing goods. This includes the cost of materials and the direct labor costs used to produce them. Subtracting COGS from revenue results in the company’s gross profit.

From gross profit, all other operating expenses are subtracted. These are costs incurred to run the business that are not directly tied to the production process. Common operating expenses include Selling, General & Administrative (SG&A) costs, research and development (R&D) costs, depreciation, and amortization.

The calculation does not factor in items like interest expense, income taxes, or one-time gains from non-operating activities. For instance, if a company has $500,000 in revenue, $200,000 in COGS, and $350,000 in operating expenses, its operating loss would be $50,000 ($500,000 – $200,000 – $350,000).

Operating Loss vs Net Loss

While an operating loss focuses on a company’s core business performance, a net loss provides a comprehensive picture of its overall financial result. Net loss is the “bottom line” on an income statement, calculated after all expenses, including non-operating ones, are deducted from all revenues. After the operating income or loss is determined, items like interest income, interest expense, and taxes are accounted for to arrive at the net figure.

A company’s operating and net results can tell two different stories. A business could have a significant operating loss, indicating its primary activities are unprofitable, but still report a net profit. This might happen if the company sold a major asset, like a piece of real estate, for a large gain. That gain is a non-operating item that could offset the operating loss.

Conversely, a company might achieve an operating profit, showing its core business is healthy, yet still end up with a net loss. This scenario often occurs when a company has a large amount of debt and the corresponding interest expense is high. The interest expense is a non-operating cost that is subtracted after the operating profit has been calculated.

Analyzing both figures is useful. The operating loss gives insight into the sustainability of the business model, while the net loss reveals the financial impact of all activities and financing decisions. Relying solely on the net loss can mask operational problems or make a sound operation appear unprofitable due to financing.

Tax Treatment of Operating Losses

When a company experiences a loss for tax purposes, it may generate a Net Operating Loss (NOL). An NOL occurs when a company’s allowable tax deductions exceed its taxable income for a given year. The calculation for a tax NOL can differ from the accounting operating loss because tax laws have specific rules about which deductions are permitted.

The benefit of an NOL is that it can be used to reduce a company’s tax liability in other years. The Tax Cuts and Jobs Act of 2017 (TCJA) established the current framework for how these losses are treated. For C corporations, the TCJA made its NOL rules permanent, allowing them to carry losses forward indefinitely. For pass-through businesses like S corporations and partnerships, these provisions are temporary and set to expire after 2028.

A limitation applies to the use of these NOL carryforwards. The NOL deduction is limited to 80% of the taxable income in the year the carryforward is used. This means a company cannot use an NOL to completely eliminate its tax liability in a future year; it can only reduce it by up to 80%.

Prior to the TCJA, businesses could carry losses back to prior tax years to receive a refund for taxes already paid, but this practice was eliminated for most taxpayers. The current system of indefinite carryforwards, subject to the 80% limitation, is the mechanism for businesses to gain a tax benefit from operating losses. This helps smooth out a company’s tax obligations over the business cycle, providing some financial relief after a difficult year.