Despite the fact that no entrepreneur wants to work at a loss, business is very unpredictable, and situations where the company during the period under review not only neither increased capital, but even reduced it, are not uncommon. Negative profit, also called loss, significantly distorts all calculated management measures. Indeed, when the main indicator, profit, literally screams that something needs to be changed, there is not much point in side indicators.
Considering one of the main indicators of enterprise performance - profitability, we can immediately note that with negative profit this indicator is practically useless. By the way, many people still doubt whether such a term as negative profitability makes sense. In fact, there is no need to argue, because any profitability is defined as profit divided by a certain indicator. So, if negative profit exists, then negative profitability also exists.
Another thing is that this indicator looks somewhat strange, because its main role is to demonstrate how well the invested funds work. In economic theory, it is believed that profitability close to zero indicates that the enterprise is operating extremely inefficiently, which is already the case when the company is concerned about negative profitability. And in this case it is not so important whether it will be equal to minus two percent or minus ten.
Take, for example, return on sales. This indicator is one of the main characteristics of the effectiveness of the company. A high rate of profitability means that the company manages to increase the price of products, without having to compensate for this with significant cash infusions in advertising or the cost of improving product quality.
On the other hand, this indicator largely depends on the characteristics of the market. In the conditions of fierce competition, sales profitability will tend to the level of 5%, while in the monopoly market indicators of 50% will not be uncommon. Also affects the rate of return on sales in cash. With large volumes, profitability is usually higher.
In turn, negative return on sales - This is an indicator that the company has not put a high enough price on its products, which does not allow it to cover costs. The higher the negative margin rate in absolute terms, the lower the price. With indicators of minus twenty percent or less, you should probably close the business altogether. A similar trend characterizes the profitability of production . Only here in the denominator is taken the sum of the costs of production and sales.
While the profitability of sales is more interesting for managers, shareholders build their analysis on the basis of return on assets, as well as return on equity. As in the first and in the second case, negative profitability is a signal for investors to withdraw investment from the project. The first indicator reflects the performance of all assets, i.e. equipment, patents, materials, etc. Its low level indicates lost profits from their use. The second indicator illustrates how the funds invested directly by the investor work. This indicator is usually compared with the average bank rate.
One way or another, with negative profits, none of the indicators considered will indicate success. The presence of profit is the key to the existence of a company in the market.