Reasons for a Negative Profit Margin
Negative margins result from businesses that do not make a profit or break even. Every business manager who encounters a net loss will try hard to reverse the situation, but the absence of knowledge about the causes of negative profit margins can make it difficult to do so. Not knowing how to remedy the situation greatly exacerbates the problem and reduces the chances of continuing business.
Profit margin is a ratio analysis method used by accountants and financial analysts to gauge the profitability of a business by comparing to previous records or other businesses within the same industry. The figures used are taken from an income statement and primarily involve sales as basis of computation. Profit margin shows how much profit is earned from every dollar worth of sales. Dividing net profit or net loss by sales will result in a net profit margin. A net loss will result in a negative profit margin.
Any decrease in revenue will result in a decrease in profits. Once a company's sales decrease below the total amount spent for expenses and cost of goods sold in a given period, a net loss will occur. Poor pricing strategies, ineffective marketing programs, competition, inability to keep up with market changes and inefficient marketing personnel are common causes of decreasing revenues. To reverse the negative margin, management must implement ways to increase market share and revenues.
High production or purchase costs of merchandise intended for sale can lead to inadequate funds to cover expenses. Cost of goods sold is directly deducted from sales. Whatever amount is left after the deduction will be used to pay for business expenses and generate profit. When cost of goods sold increases to the point that there are not enough funds left to support all expenses for the period, a net loss will occur. The higher the cost of goods sold, the lower the net profit margin becomes.
Budget overruns or unexpected costs incurred in excess of budgeted estimates can result in a negative profit margin. Even if target revenues are met and cost of goods sold kept within projected estimates, a negative profit margin can still occur if expenses incurred during the current period go beyond gross profit. For example, XYZ Company's books show the following balances: $100,000 sales, $70,000 cost of goods sold and $40,000 expenses. Deducting $70,000 cost of goods sold from $100,000 sales resulted iin a gross profit of $30,000. But expenses exceeded gross profit and resulted to a net loss of $10,000 or profit margin of -0.10 (-$10,000 divided by $100,000).