What Is a Negative Profit Margin Called?
Profit margin is one of the most important financial ratios your small business can review to monitor its performance. This metric measures the percentage of your sales revenue you keep as profit, or net income, in an accounting period. According to Cheng Lee, et al., in “Statistics for Business and Financial Economics,” when your business generates a net loss, you get a negative profit margin, which business owners typically refer to just that way. A negative profit margin expresses the loss, rather than net income, as a percentage of sales.
Before you can determine your profit margin, you need to know your net income or net loss, which equals total revenue minus total expenses. Net income is positive, while a net loss is negative. A net loss means your expenses exceed your revenue. Expenses include items such as rent, salaries, income tax and the cost of your products. You can find these on your income statement. For example, if you have $750,000 in revenue and $1 million in expenses, subtract $1 million from $750,000 to get -$250,000, which represents a net loss.
A profit margin as a percentage equals the net income or loss for the period, divided by total revenue, times 100. Because a net loss is a negative number in the formula’s numerator, you get a negative percentage result. For example, with revenue of $750,000 and expenses of $1 million, your negative profit margin equals -$250,000 divided by $750,000, times 100, or -33 percent. This means your net loss for the period equals 33 percent of your sales. For every $1 of sales, you lost 33 cents.
When your profit margin is positive, you want it to be as high as possible. But when it is negative, the closer the percentage is to zero, the better. The smaller the negative percentage, the less money you lost relative to your sales. For instance, on $750,000 of revenue, a profit margin of -33 percent would be better than -50 percent. With the -33 percent margin, you lost $250,000, but a -50 percent margin indicates a net loss of $375,000, or a loss of 50 cents for every dollar of sales.
A negative profit margin might occur if your costs become too high or your revenue suffers a decline. Review your revenue and expenses over recent periods to identify any changes and determine the cause of the negative margin for the period in question. Also, compare your profit margin with those of other businesses in your industry to determine an acceptable margin percentage. This can help you determine whether the negative margin is a one-time occurrence or the result of a larger problem with your business and cost structure.
A small business sometimes has a negative profit margin for its first few years of operation as it incurs expenses while building its client base. For instance, a new retail store might pay rent and other expenses but generate insufficient sales to cover these costs. A business can sustain this only as long as it has cash reserves or other sources of capital. To succeed, a company must ultimately grow its sales or reduce its expenses so that it produces net income and a positive profit margin.