What Happens When You Have a Negative Net Profit Margin?

No one goes into business to lose money, but nearly every business faces negative numbers now and then. When that negative number is your net profit margin, it may seem like you're headed out of business. While there is no doubt that a negative net profit margin signals trouble, the reality is that you can often overcome this issue if you identify the source of the problem and act quickly to correct it.

Breakdown

Before you can determine the source of poor performance, it's good to revisit the net profit margin definition so that you know exactly what it is and what it is not. The net profit margin begins — unsurprisingly — with net profit: the amount of money you have left over after you subtract all expenses from your revenue. To generate the profit margin, you compare this number to the net sales, the amount of money you brought in over the period. You can express this margin as a ratio comparison or divide the net profit by the net sales to get a percentage. A negative net profit margin results from the "net" part of the equation — the balance between revenue and expenses is off. It means that the money you make from selling your products or services is not enough to cover the cost of making or selling those products or services.

Stage

All businesses go through stages; a business requires an input of capital to get started or to expand, and this input typically exceeds sales revenue for some period of time. In the same way, a company whose business is seasonal, like a Christmas tree company, may need a large output of expenses at certain parts of the year to have revenue in later parts of the year. If any of these things describe your business, your negative net profit margin may be periodic and somewhat temporary. Remember that a profit margin is measured for a specific period of time; if your reporting does not reflect the input of capital in a prior period, your negative number may be deceiving. In other cases, it may indicate a need for additional capital until the business is able to support itself.

Pricing

One of the other major areas of issue is product pricing. If you're not pricing your products high enough, you may not be able to cover the expense of making them. Many business owners make the mistake of looking only at product markup, which is the amount added to the cost to make the price, and not at gross or contribution margin, the difference between the selling price and the cost. While it may seem like these two things are equivalent, they actually show two different stories. If you think your prices may be an issue, complete a product-by-product analysis using contribution margin. The contribution margin compares the revenue from a product to the expense of selling the product. This includes not only the cost of the product itself, but the value of marketing, staff and equipment devoted to that product. A contribution margin analysis can show you which of your products generates the most profit and where you might cut expenses or raise prices.

Sales

Sometimes, a negative net profit margin results purely from lack of sales. Revenue may fluctuate from period to period, but many of your operating costs remain the same. This means that lackluster sales won't generate enough income to pay for building rent, electricity and the like. In this case, you need to pinpoint the reason for slow sales and address it head on. This is one of the harder areas to tackle, as there are a number of factors that may be out of your control like the general economy, natural disasters and even weather. Adjust what you can control, and look at reducing your expenses to account for the things you cannot.

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About the Author

Nola Moore is a writer and editor based in Los Angeles, Calif. She has more than 20 years of experience working in and writing about finance and small business. She has a Bachelor of Science in retail merchandising. Her clients include The Motley Fool, Proctor and Gamble and NYSE Euronext.