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10/6/07

What if I Experience a Loss?

In everyday speak, a loss is a bad thing. Whether the loss is love, life, or money, a loss is never good. However, because I deal primarily in business transactions and financial insight, we will disregard all other losses and concern ourselves solely on financial loss.

For example purposes, let us pretend that you own a business. You want to make a lot of money in your business. But sometimes, a loss happens. Now what? Do you pack up shop and leave? The answer is: it depends.

If you are a new company, chances are you are going to be operating at a loss in the beginning. This is due to all the initial costs that were necessary to establish your business. Does this mean that after a year, if the company is not profitable you should close shop? What about after two years? How about three years? Once again, your decision depends on your situation. If you are a new business, you probably should not pack up after a year. But if you have no long term plan and you keep losing money year after year, you might want to think about cutting your losses.

Many people make the classic mistake of justifying their continuing a failing business because of all the time and money that has already been used for the business. A classic statement is something like, “I already put $X into the company, I might as well ride it out.” This is a terrible way to think because this usually results in further monetary loss! The time and money that have already been spent are sunk costs. A sunk cost is defined as “a past outlay or loss that cannot be altered by current or future actions.” This means that “riding it out” will not recoup the loss. You have to move on and stop wasting additional dollars!

On the other hand, there are some pretty big companies that operate at a loss because their future profit potential is huge. Two companies that currently do this are Sirius and XM Satellite Radio. Because of the costs of launching satellites, acquiring customers, and developing packaging contracts with auto makers, these companies have been operating at a loss for years. However, as more and more people sign up for the service and as equipment costs decrease, these companies come closer to becoming cash flow positive with every passing quarter.

If your company is designed to follow some sort of long term profitability plan, then it would not make sense to close shop after a year or two or three of losses. Just makes sure that your future profits are viable. Do not fool yourself into thinking that future profits will come if such a future profit business structure was not part of your original intention or plan.


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