Your company accounts, the story of your business - Part 5 - What about losses?

  • by Carole Jordan
  • 20 Nov, 2017
what do when your business makes a loss businessheads brighton accountants and consultants

In response to a request from one of our readers I’m going to address losses, which occur in a business on a regular basis for a variety of reasons.

Sometimes losses are part of the plan, particularly in the early days and also at times of restructuring or investment. What's important at these times is that losses are controlled and growth from this point is expected. Mainly losses are unwanted and sometimes, the worst times; completely unexpected.

The effect of losses in your business

Each year of losses will reduce historic accumulated profits and may lead to your balance sheet showing a negative figure under the ‘Shareholders Funds’ heading. This is what’s known as an insolvent balance sheet. Essentially, the liabilities have grown to more than the assets.

Lack of dividends 

With accumulated losses in your business you will be unable to declare dividends. This could leave you, as the shareholder director, in a position where you have to pay more tax on your drawings. Dividends are taxed more conveniently lower at 7.5%, 32.5% and 38.1% than payment of a salary which will incur, not only tax at 20, 40 or 45% but also employees AND employers national insurance which can add up to 24.8%.   The effect of paying more tax and national insurance will increase your costs and make it more difficult to recover a profitable outcome. 

In the short term, it is possible to borrow from your company to fund your drawings but please take advice about this as it has to be carefully managed. 

Losses also affect the view of a company by shareholders, funders and other interested parties. So, it’s important to understand what your objectives are for profitability and to take positive action to achieve these.
 

A shortage of cash flow  

There is an old saying that cash flow is the lifeblood of a business and there is nothing more true!  Losses are effectively an excess of expenditure over income and so cash will be eaten up in the process. This lack of cash will undermine future investment and growth. If you are unable to pay your debts as they become due then you are insolvent and should carefully consider whether you should continue to trade. If you incur more debt this could leave you open to legal action if your company ultimately goes into liquidation owing money.

 

A need to raise funds  

When a business is loss making it is difficult to raise funds because it doesn’t engender confidence in the lender. Going to business banks for funding is likely to be a waste of time unless there is a strong history in the company, a good product and a receptive market. Often the reasons for losses are the lack of one or some of these factors. 

Raising funds in a loss making situation usually means using your own finance facilities based on your personal assets or looking to friends and family to support you. If you or those you know will be investing in your business you should have a solid actionable plan for achieving a profitable outcome and be aware of the timescale within which you will need to see results.

Using your Accounts to identify where & why losses occurred

You’ll be aware of the difficulties you’ve faced and may be taking action to mitigate some or all of them. Analysing your figures will give you a sharper focus on exactly where and to what extent you need to make changes. Reviewing your figures continually will measure the degree and speed of your improvements and highlight where you should change or put greater emphasis on each of your strategies to be sure they deliver results in a reasonable timescale. 

I’ve run through the key figures on your accounts in the last four articles and one very important ratio brings all of these together...

Understanding your breakeven level

Your breakeven level is the point at which your gross profit just covers your overheads leaving your net profit at zero. If your overheads in the year are £30,000, then your gross profit must be £30,000 for you to breakeven. And, if your average margin is 30% then you will need to make sales of £100,000 to breakeven.

Your figures would look like this:

Sales: £100,000

Cost of Sales: £70,000

Gross Profit: £30,000

Overheads: £30,000

Profit/Loss: £0.00 

In the above case the breakeven sales level is £100,000.

Bringing about movements in sales, cost of sales, prices or overheads will affect your profitability. Everything you do every day will have an effect on at least one of these. 

Bringing your breakeven level down is an important objective for business management. In simple terms if it were possible to increase the margin here by just 2% then the breakeven level would decrease to £93,750 (£30,000 overheads/32% margin x 100% = £93,750 sales) and on £100,000 sales the gross profit would be £32,000 leaving £2,000 net profit after £30,000 overheads. 

Alternatively, reducing overheads by £2,000 could provide this net profit and would reduce the breakeven level to £93,333 (£28,000 overheads/30% margin x 100% = £93,333). However, unless you can identify waste in your overheads then a reduction in your infrastructure could undermine the future of your business. 

These options are part of the decision making when creating a strategy to deal with losses. 

See my comments earlier in this series for suggestions on how to analyse your figures . Keep your eyes peeled for my blog next week on ‘How to be objective in the assessment of your business’.


If you'd like to read the rest of the blogs in this series then see here - Understanding the story of your business .

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In response to a request from one of our readers I’m going to address losses, which occur in a business on a regular basis for a variety of reasons.

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