What is return on sales?
Return on Sales (ROS) is a percentage statistic used to determine how efficiently a business converts sales into profits, which means the amount of profit made per dollar of sales revenue earned.
If a company’s return on assets (ROA) increases, it indicates that it is growing at a consistent and efficient rate. On the other hand, a declining return on investment (ROI) may mean major financial issues.
The ability to increase sales can aid in improving return on sales, albeit doing so may necessitate changes to the current strategy. Return on Sales can be used by any business plan in which net income and cradle are on the plus side.
The Importance Of Return on sales
Through continual improvement, businesses should strive to minimize expenses while increasing revenues. In the case of a company that generates $50,000 in sales but spends $35,000 to do so, its overall efficiency is far lower than it should be.
Furthermore, without the point of view that a Return on Sales calculation provides, you may not know that, even though your product sales are high from your product manager and you seem to be on the right path to being the next market leader, you are actually on the way to your company’s downfall.
When You Should Calculate Your Return On Sales
You should only use return on sales to compare firms in the same industry, ideally with similar business structures and yearly sales data. Compared to a technological firm, a food store has smaller margins and lower Returns on Sales. Companies in diverse industries with different business structures have vastly varying operating margins, making comparisons with EBIT in the numerator misleading.
The Return On Sales Formula
Companies can calculate their return on sales by dividing their operational profit—before taxes and interest are subtracted—by their net sales for a certain period, such as a year.
Consider the following scenario: your software company generates $900,000 in revenue but incurs $725,000 in expenses. What is the amount of your operational profit? In this particular instance, the sum is $175,000.
Then you divide the profit by the total sales figure to get your return on investment (ROI) and get 0.194.
To convert this value to a percentage, multiply it by 100, yielding 19% of the total. A healthy Return on Sales, to be sure! Many businesses would be satisfied with a 5-10 percent return on sales.
Following the calculation of return on investment, a company can establish how cost-effective it is in supplying products to the market.
Return of Sales vs. Operating Profit Margin
Return on sales and operating profit margin are two financial ratios commonly used interchangeably. The way their different formulae are derived is the crucial distinction between each usage. Operating income divided by net sales is the basic formula for calculating operating margin. The numerator of a return on sales calculation is typically profits before interest and taxes (EBIT), while the denominator is still net sales.