How to Have a Low Net Profit

Generating net profit is the main objective of running a business. It is determined by the difference between expenses, including cost of goods sold and revenues. A low net profit can drive your business to bankruptcy, but knowing how companies end up with low net profit can help you identify and avoid the factors that cause such undesirable profit levels.

Net sales less cost of goods sold yields gross profit. Gross profit less expenses, including tax, results in the net profit. Net profit is the bottom line of an income statement. It shows you the amount of earnings distributable among owners of the business. Net profit is measured against industry averages using a ratio analysis tool called net profit margin. Dividing net profit by sales and multiplying the result by 100 yields the net profit margin. A low net profit is one that has a net profit margin lower than industry-average margins.

With all other accounts being equal, a reduction in selling price per unit causes both gross profit and net profit to decrease. Some companies are forced to reduce selling prices due to stiff competition. Slow-moving stocks and outdated products are often sold at reduced prices to recover capital.

Cost of goods sold normally consumes the biggest share of revenues. An increase in cost of goods sold per unit that is not accompanied by an equivalent or greater percentage increase in selling prices will result in a lower gross profit. With expenses remaining at a constant level, such a decrease in gross profit will reduce your net profit. Purchasing higher-priced materials, an increase in employee wages and incurring more production overhead are some of the things that can increase the cost of goods sold.

A company may experience a low profit margin if its expenses increase while revenue and cost of goods remain at the same level. Inflation and other economic factors typically cause expenditures to go up ahead of any increase in selling prices and sales volume. When expenses are allowed to increase without a corresponding selling price adjustment, a business will experience a deteriorating net profit margin. Many businesses are unable to raise selling prices even if expenses have gone up considerably and profit levels have fallen below industry averages.