A company's profit is a measure of how well it executes its business strategy. Sometimes profit doesn't measure up to expectations for a variety of reasons. This is reflected in the company's profit margin, which is the company's net income divided by sales. The profit margin is also a measure of the company's efficiency. Management must assess why its profit margin is below expectations and make adjustments. To fix profit margin, the business must increase revenue, reduce costs or do a combination of both.

Calculate Growth Rates

Step 1

Re-create your company's income statement using a spreadsheet program. Enter the line items from your income statement for different time periods such as the current and prior year. Use a longer time series such as a few years to better analyze the data. This allows you to identify trends in the drivers of profit margin such as sales and operating expenses.

Step 2

Calculate the sales growth rate so you can compare your current sales to prior years' sales. For example, if your company had sales of $1.8 million last year and $1.5 million this year, that represents a decline of almost 17 percent. To calculate the percentage, subtract $1.5 million from $1.8 million, divide the result by $1.8 million and multiply by 100.

Step 3

Calculate your gross profit or the difference between sales and cost of goods sold, which are the raw materials converted to finished products for sale or inventory purchases for sale during the period. The higher your gross profit, the more money your company keeps for itself. The gross profit margin, another measure of operating efficiency measures your gross profit in percentage terms by taking the difference between sales and cost of goods sold, dividing the result by sales and multiplying by 100. For example, if sales were $1.5 million and cost of goods sold were $900,000, your gross profit is $600,000 and your gross profit margin is 40 percent.

Step 4

Identify why sales decline from one period to the next. Lower demand, poor execution of your company sales strategy and increased competition are examples of reasons for a decline in sales.

Step 5

Calculate the growth rate of your cost of goods sold for the period. For example, if cost of goods sold was $700,000 the prior year and rose to $900,000, the growth rate in cost of goods sold is 29 percent, or $900,000 less $700,000 divided by $700,000 multiplied by 100.

Step 6

Identify why cost of goods sold increased for the period relative to growth in sales. In this example, sales declined but cost of goods sold rose. Some reasons for this could be an increase in raw material costs and poor inventory management.

Step 7

Calculate the growth rates for individual operating expense items. These are the expenses that your business subtracts from its gross profit to arrive at net income. Examples of operating expense items include rent, utilities, salaries, depreciation and other day-to-day expenses of running the business.

Step 8

Subtract total operating expenses from gross profit to arrive at net income before taxes. Subtract taxes to arrive at net income after taxes. Calculate the growth rate for net income. For example, if net income after taxes was $200,000 this year and was $317,000 the prior year, this represents a decline of almost 37 percent. To arrive at the percentage decline, subtract $200,000 from $317,000, divide the result by $317,000 and multiply by 100.

Step 9

Compare your company's profit margin with that of prior years to spot trends and any unusual up or down movements. For example, the profit margin is 13 percent, which is $200,000 divided by $1.5 million. This compares to a profit margin of 18 percent in the prior year, or $317,000 divided by $1.8 million.

Making Adjustments

Step 1

Increase your revenue based on your business strategy. A low-price strategy means that you're willing to reduce your selling price to increase revenue. If this strategy works, you should see a pick-up in revenue assuming that your customers are price-sensitive, meaning that the main way to get them to come back is to offer a lower price. On the opposite end of the spectrum is a high-price strategy, where you sacrifice volume but increase the price on items for sale. You can also adjust prices to capture different consumer segments like high-margin and low-margin goods. A common example is a car manufacturer that produces luxury, mid-size and economy cars. The car maker can make a higher profit margin selling luxury cars but will sell fewer of them because of their high price tag. On the other end of the spectrum, the company will make less profit margin off economy cars, but will be able to sell more of them since more customers can afford them.

Step 2

Identify ways to reduce costs starting with your cost of goods sold. The formula for cost of goods sold is beginning inventory plus purchases less ending inventory. Ways you can reduce your inventory costs include purchasing in bulk to take advantage of supplier discounts and negotiating terms with suppliers of raw materials. Cut back on cost of goods sold to the extent that it does not impinge on your sales.

Step 3

Identify other operating expense items that you may reduce without sacrificing the performance of the company. Salaries are often a huge expense item. Companies often reduce staff or employee work hours to trim this cost. However, you have to weigh the impact of a lower headcount on your revenue. For example, there might be fewer sales people to help customers or fewer cashiers to ring up sales, both of which might mean lost business.

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