A Net Operating Loss (NOL) or Tax Loss Carryforward is a tax provision that allows firms to carry forward losses from prior years to offset future profits, and, therefore, lower future income taxes. The way a Tax Loss Carryforward works is that a schedule is generated to track all cumulative losses, which are then applied in future years to reduce profits until the balance in the TLCF is zero. An NOL carryforward schedule is commonly used in financial modeling.
What is the Purpose of an NOL/Tax Loss Carryforward?
Tax Loss Carryforwards exist so that the total lifetime taxes for a firm will, in theory, be the same no matter how their profits and losses are spread out.
Example if firms could NOT carry forward losses:
A company that had a loss of $10 million in 2018 and a profit of $10 million in 2019 with a 30% tax rate would pay zero tax in 2018 and $3 million in 2019. Its total profit before tax in 2018 and 2019 combined was zero, yet it paid $3 million in taxes.
Compare that to a different company that also had $0 of profit in 2018 and $0 of profit in 2019. This company would pay zero taxes and had a total pre-tax profit of $0.
So why would the first company pay $3 million in taxes while the second company paid none? The first company is much worse off due to the distribution and timing of its profits.
To address this issue, tax loss carryforwards were created.
Building a Tax Loss Carryforward Schedule
The easiest way to keep track of a TLCF schedule is to create a model in Excel. In the screenshot below, you can see how a financial analyst creates the schedule.
Steps to create a tax loss carryforward schedule in Excel:
Create a line that’s the opening balance to carry forward losses
Create a line that’s equal to the current period loss, if any
Create a subtotal line
Create a line to calculate the loss used in the period with a formula stating that “if the current period has taxable income, reduce it by the lesser of the taxable income in the period and the remaining balance in the TLCF.
Create a closing balance line equal to the subtotal less any loss used in the period
Next period’s opening balance equals the last period’s closing balance
Example Tax Loss Carryforward
Below is a screenshot of a tax loss carryforward schedule built in Excel. This is taken from CFI’s e-commerce/startup financial modeling course, in which a company has the ability to carry forward losses due to the significant losses expected to be incurred by the business in its first few years of operation.
The best way to learn how to build a TLCF schedule is by practicing. By using the example provided, you can see how it was designed and test yourself to create your own in Excel. If you want a completed example to work with, check out CFI’s financial modeling templates library of completed models from beginner to advanced.
IRS Net Operating Loss NOL Carryforward
The Internal Revenue Service (IRS) classifies a tax loss as a Net Operating Loss (NOL) and provides specific rules about how to perform a Net Operating Loss carryforward.
According to the IRS, it’s very important to keep good records. Specifically, you should maintain complete records for all tax years that incur a Net Operating Loss for at least three years after using NOL carryforward.
To learn more, read the details from the IRS NOL carryforward guidelines here.
Always consult a professional tax advisor before filing any tax forms.
Thank you for reading this guide to tax losses, the NOL carryforward process, and how they can be useful when building a valuation model. To keep learning and progressing your career, these additional CFI resources will be helpful: