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Return on sales ratio

Return on sales 101: Understanding the ratio, importance, formula, and real-life example 

Key Takeaways
  • Return on sales (ROS) is a metric that calculates the profit concerning operational costs. It explains the logic between revenue and operations.
  • Return on sales is calculated by dividing operating profit by net revenue.
  • ROS benefits your business by helping you improve operative potential, cutting material and labor costs, and aims at improving revenue by increasing sales figures.

All the revenue generated isn’t business profit.

To evaluate your company’s actual health and profitability status in a given time, you need to measure the revenue in relation to operating costs.

There are various ways to assess where your business is moving, profitable or not.

One of the most effective ways of calculating this is using the Return on sales (ROS) metric.

This blog covers the definition of return on sales, the formula, and influencing factors. So, let’s begin.

What is a return on sales ratio? 

The return on sales ratio measures how your company effectively generates profits from its sales. It measures the company’s performance by calculating the actual profit made.

ROS is calculated when you divide your operating profit by net sales generated. 

It is one of the most influential metrics that explain the logic behind the budget and sales strategies

Thinking about what increasing or decreasing ROS depicts? See the table below. 

Investors and creditors are the ones most interested in learning about a company’s return on sales ratio. They use this ratio to measure the performances between two companies for a given period. 

Let’s learn more about the importance of the return on sales. 

Why is the return on sales important? 

The return on sales ratio is important for every business, along with creditors and investors.

It helps creditors and investors make various decisions like reinvesting in the company, the company’s ability to pay back debts or pay potential dividends, etc.

It helps businesses measure yearly performance as the expenses and revenue keep varying yearly. So, the year making the highest revenue can only be considered profitable if the operating costs are included.

You can identify your company’s growth by comparing it to your competitors. However, it would be effective only when comparing companies of similar business lines and the same size.

For example, “Company A” makes $100,000 in revenue and spends $70,000 on operations for a given year. Conversely, “Company B” makes the same revenue but spends $50,000 on operations for the same year.

Company B, excelling in cost-cutting, will have a better return on sales ratio. Hence it will make higher profits and attract potential investors.

What is the return on sales formula, and how to calculate it?

ROS is calculated by dividing the operating profit or operating margin by your net sales revenue from your sales. Check out the return on sales formula below. 

Return on Sales= (Operating Profit/Net Sales) x 100 

The percentage in the return on sales formula above signals the profit made for every dollar you earn. 

You can calculate the return on sales of your company with these four simple steps. 

Steps to calculate return on sales ratio

Let’s understand with an example to calculate return on sales. 

Suppose ABC is a software development company. And the company spent $1,200,000 as an expense this year, and its net sales for the year are $5,000,000. 

Now, once you subtract all your expenses, you’re the Revenue made, and you will get your profit. See below. 

Operating Profit= Revenue – Expenses 

= $5,000,000 – $3,800,000 

= $1,200,000 

So, now you have $1,200,00 as your operating margin. So, now we will use the value in return on sales formula. See below.

Return on Sales (ROS) = (Operating profit ÷ Net sales) x 100 

= ($1,200,000 ÷ $5,000,000) x 100 

 = 24% 

Additionally, it’s also important to remember that even if the ROS is 24% in this case, it doesn’t mean that the company is profitable. 

One thing to know about this metric is that it does not consider non-operating expenses such as interest, income tax, and other financial expenses. 

Not including these figures enables the creditors and investors to understand the expenses associated with the business’s core operations. 

Return on sales tells about the company’s operational efficiency. So that’s why it is also known as the operating profit margin. 

Comparison of ROS to other financial ratios  

To know your company’s overall financial performance, you must compare your return on sales with other key financial ratios, such as return on assets (ROA) and return on equity (ROE).   

Here’s to notice. 

  • ROS measures profitability concerning your sales.  
  • ROA measures profitability concerning your assets. 
  • ROE measures profitability concerning your equity. 

ROS is a good metric to evaluate profitability concerning sales revenue.

But, remember, it does not consider non-operating expenses like financing structure and taxes. Therefore, looking at other financial ratios and metrics essential to assess the company’s overall financial health is best.

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6 Factors influencing your return on sales  

Learn how you can utilize the return on sales formula to assess a company’s profitability. Six key factors can impact the ROS of your company.

1. Industry benchmarks 

Industry benchmarks are an indicator for companies to generate a level of profit. For example, if the industry return on sale is 10%, you are generating 12% ROS, which is considered reasonably good.

2. Your operating expenses 

A high cost of operating expenses will lead to a decrease in the ROS value. Thus, you will generate no or less profit. 

3. Gross profit margin 

The higher the gross profit margin of a company, more will be the ROS value. Thus, the company will be able to generate more profit from its sales revenue.

4. Sales growth 

Your company’s sales growth directly affects its return on sales ratio. Therefore, tremendous sales growth will increase the chance of generating more profit.  

When your ROS shows improvement with every passing year, your company becomes profitable. E.g., If your company shows 30% ROS for 2019-20, followed by a 35% ROS for 2020-21. It reveals that your business is progressing in an upward direction.

6. Competitors 

You work in the same environment as your competitor, so you incur similar material and labor costs. Strategies to beat your competitors to get a higher ROS.

Let’s learn how the return on sales ratio can help improve our business.

How do you improve ROS to boost your business? 

A high ROS means your company is generating good profit from your sales. Here’s how you can improve your business with the help of ROS.

1. Decreasing your operational expenses 

ROS counts operational costs. It encourages cutting operating expenses. This enables the organization to cut down on unnecessary operational expenses. This can be done by building good contact with your suppliers and negotiating the prices.  

You can employ technology solutions like Customer Relationship Management (CRM) to run the operations efficiently. Using a CRM tool is cost-effective yet systematic. 

2. Increasing your sales

If your company generate more net revenue, it can get a high ROS value which means more profit.  Sales Activity Tracking will help you find how your reps perform and the areas to improve. 

You can identify roadblocks based on your Sales Reports and leverage the insight for Sales Forecasting. 

3. Improving your gross profit margin 

Gross profit margin directly impacts your return on sales. So, by increasing its value, you can get a high ROS value. Thinking how to improve your it? Here are some tips.

Tips to improve your gross profit margin

4. Saves labor costs to an extent 

This includes spending more upfront and decreasing the labor cost later. For example, having Workflow Automation or investing more in sales training will produce skilled labor. 

5. Boost your operative efficiency 

You can get your ROS value and business on good count with high-performing operational ability.

A robust CRM and automation tool is the right solution to boost your reps’ day-to-day task efficiency.

A CRM can help you manage your contacts, sales pipeline management, track sales activities, and automate your tasks to scale your business in no vain.

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Return on sales is crucial for businesses to monitor profitability and the company’s financial success.

It is one of the most influential metrics used by various business stakeholders: E.g., investors, creditors, competitors, and many more.

A good return on sales indicates that the organization is making sound decisions and grabbing potential sales opportunities.

Return on sales (ROS) shows the company’s operational efficiency. Therefore, your sales team should be efficient with their tasks to gain a good ROS value.  

That’s why CRM for sales can be a game changer! Take 15 days Salesmate CRM trial for free. 

Frequently asked questions on ROS 

What is a good return on sales ratio?

When you divide the net income by net sales, you will get the return on sales. A ROS between 5% and 10% is good for most companies. This may seem like little; however, if your business heads into financial trouble, this number would be negative. 

How do they differ: Return on sales vs return on investment 

ROS measures the efficiency of a company concerning its net sales revenue, whereas ROI measures how efficiently a business performs concerning its investments.

How do they differ: Return on sales vs return on equity 

Return on sales and return on equity differ based on their reference point to measure gauge performance. In simple words, ROI considers sales revenue, whereas ROE considers equity.

How do they differ: Return on sales vs operating profit margin  

When calculating ROS, you take earnings before interest and taxes (EBIT), whereas the operating profit margin formula considers the operating income. Once the operating expenses and cost of goods are deducted from net income, your remaining amount is your net operating income.

Dhanashree Pal

Dhanashree has been into writing since her teens. She believes writing is the best way to express and explain everything happening in this world. Reading and imagining are something she can do for hours. Enthusiastic about exploring new places and food. Young and hopeful of becoming better with every passing day.

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