An old factory
Industrial on Picspree

Cause and solution of business losses – what are the common ones?

The cause of companies’ losses

All companies incur losses after a few years. There are two reasons for this:

  • People make mistakes, so products are damaged and cannot be sold, resulting in income loss to the company.
  • It is not possible to reflect lost income in accounting.

Thus, at the close of the accounts, companies discover that revenues are less than expenses. Usually, this concerns a (relatively) small amount of money―just big enough to ensure that February salaries cannot be paid. But of course, that’s unacceptable, so businesses cut back.

Mistakes are made

No entrepreneur ever considers the best way to cut back before he runs into a loss. As a result, companies commit weird cutback mistake. These mistakes only ensure that the problems get bigger. As a result, more and more employees are laid off.

To cover losses without the need for budget cuts, a company needs to apply three techniques:

  1. During the year, it has to gain an insight into its profits or losses.
  2. It has to have reserve capital to which it regularly adds funds to cover losses.
  3. It needs a way to prevent business owners and CFOs from inadvertently spending this reserve capital.

The reserve account

Include the general ledger for profit and loss in your accounting. Book the balance of the cash/bank journal against the general ledger for profit and loss daily/weekly/monthly to establish the amount of profit or loss.

To establish the reserve necessary to cover losses, companies can use a reserve account. In order for companies to cover losses and prevent cutbacks, they need a new kind of account in their accounting. A reserve account is a type of general ledger account that is never closed off and to which a savings account is linked. On the last day of the month, the new balance is calculated and brought forward to the next month. On December 31, a new balance is calculated that is brought forward to January of the next year. The balance of the reserve account should always be equal to the balance of the savings account. The reserve must be in a savings account to avoid that the errors that led to the loss, also lead to the reserve being accidentally spent.

Reserve money to cover losses

Small businesses need to add a value-added reserve account in their accounting. They have to book 5% of their added value to the value-added reserve account and savings account every month. At the end of the year, at the close of the accounting, if they discover they have incurred a loss, they can use the reserve account to supplement the balance of the current (bookkeeping) account and then transfer the same amount from the savings account to the current (bank) account. When companies have liquidity problems, they can also use the reserve account to supplement the balance of the current (bookkeeping) account and transfer the same amount from the savings account to the current (bank) account. Thus, cutbacks can be avoided.

Shareholders will make more money

Companies that use equity capital must add a value-added/dividend reserve account and a share capital/losses reserve account in their bookkeeping. The share capital/losses reserve account must be linked to a savings account.

The share capital is booked on the share capital/losses reserve account. This account is used to cover losses and liquidity problems.

Then 5% of the added value is booked to the value-added/dividend reserve account monthly. This amount is used to pay out shareholders’ dividends. Companies that payout 2.5% of the added value as dividends annually can cover losses up to about 80% of the turnover. (Currently, the dividend/distribution of profits is about 2% of the added value once every two years.)

Companies may decide to reduce or increase their reserve after a few years.

Healthy companies will get tax breaks

Given the enormous damage, cutbacks inflict on the economy and society, this must be avoided at all costs. For this reason, we recommend the government of your country exempt the balance of the reserve account from taxes. This will allow companies to use all that money to prevent cutbacks.

New companies do not incur losses during their first two to eight years. As long as the market is growing by more than 2% a year, the growth in turnover is sufficient to cover losses. As a result, the losses are invisible, and the company shows a profit for a few years. These profits can be used in the traditional way, and in that case, the company pays tax on this money. Or the profit can be booked to the reserve account.

Covering existing losses

A company includes the general ledger for profit and loss in its accounting and uses it to calculate the loss. The loss then appears to be much larger than 5% of the added value of the past year, or the share capital the company had access to over the past year. This is because companies that have implemented cutbacks never used the proceeds to cover their losses.

How can they cover this existing loss? They have actually been working on this but they didn’t have an essential tool. When companies incur a loss, they raise their prices and start asking money for services they previously offered for free. This should generate sufficient additional profits to cover the loss.

Covering a loss will fail without a general ledger for profit and loss

But without a general ledger for profit and loss, they couldn’t see that and used that extra income to disburse profits to owners, CEOs, and shareholders. Once companies have implemented the general ledger for profit and loss, they will however be able to see that additional profits are being used to cover the loss.

Large companies can use their equity capital to cover their losses. But again, this is only possible when they have implemented a general ledger for profit and loss.

Once the existing loss is covered, companies can lower their prices again. From then on, the reserve will suffice to cover future losses.

Alternatively

If you ask someone if they are in debt, they are deeply offended. Still, every homeowner finds it quite normal to have a debt to the bank for thirty years.

Every government in the world has a budget deficit. Some budget deficits are only forty years old. Others are hundreds of years old and still growing. In some cases maybe even a thousand years old.

Virtually every company in the world has a loss or budget deficit. Sometimes that loss is only a few years old. Sometimes that loss or budget deficit is 150 years old.

If the proceeds of the cuts are not high enough to cover the loss or budget deficit. It could take several decades to do that. Sometimes even a few hundred years.

The worst method for a company to close the loss/budget deficit is to employ slaves. Slaves produce low-quality products and keeping slaves causes losses.

The worst method for the government to close its budget deficit is to establish a dictatorship. Dictatorships reduce production and reduce salaries. As a result, companies are left with losses and citizens have no money to pay taxes.

The best way for companies to cover the loss/budget deficit is to include the general ledger for profit and loss and the reserve account in their accounts. Produce and sell high-quality products and pay the highest salary to the employees who make the largest contribution to the turnover.

The best way for the government to close the budget deficit is to include the general ledger for profit and loss and the reserve account in the accounts, and by encouraging companies to do the above so that employees with a good salary can pay high taxes. That government can use, both to improve the general standard of living and to cover their budget deficit.

Smart savings make companies healthy