What Is an Unrealized Loss?

An unrealized loss is an anticipated loss due to a decline in the value of an asset before it is sold for cash. It is also known as a paper loss, as no actual cash exchange occurs. An unrealized loss is only recognized when the asset is sold, and thus it is not included in a company’s financial statements until that point. It is important to note that a paper loss is not considered a recognized loss until it is realized.

Examples of Unrealized Losses

An unrealized loss occurs when the current market value of an asset is lower than its cost. A common example of an unrealized loss is when an investor purchases a stock at $50 per share and the stock then drops in price to $25 per share. The investor has an unrealized loss of $25 per share. Similarly, when a bond is purchased at a par value of $1,000 and the current market value of the bond drops to $800, the investor would have an unrealized loss of $200.

Implications of Unrealized Losses

It is important to understand that unrealized losses can have real implications both for a company’s financial statements and for an investor’s portfolio. The impact of unrealized losses depend on the type of asset involved. For businesses, unrealized losses can affect a company’s balance sheet because they will reduce the value of the asset and thus reduce the company’s assets and equity. For investors, unrealized losses can have a direct effect on an investor’s portfolio and their return on investment.

Managing Unrealized Losses

Unrealized losses can be managed in several ways in order to reduce the potential impact of a decrease in market value of an asset.The most common strategy is to hold onto the asset until the price recovers in order to offset any actual losses. Alternatively, investors and businesses may look to diversify their portfolios to reduce volatility and the magnitude of unrealized losses. It is important to note that, though unrealized losses do not actually affect cash flow, investors should still pay attention to them and manage them in order to limit the effects of a decline in market value.