What is Return on Sales Ratio?
Return on Sales is a financial ratio that shows how efficiently a company is able to generate operating profit from its revenue. It is used to measure the performance of the company by analyzing what percentage of the revenue eventually results in profit for the company rather than being spent towards paying the company’s operating cost.
- It can also be used to provide insight into how much profit is being produced per dollar of sales. Return on sales (ROS) is also known as operating profit marginOperating Profit MarginOperating Profit Margin is the profitability ratio which is used to determine the percentage of the profit which the company generates from its operations before deducting the taxes and the interest and is calculated by dividing the operating profit of the company by its net sales. since it gives an idea of the operational efficiency of the company.
- It implies whether the company’s operation is running at its optimal potential or not.
- Consequently, this ratio forms a crucial part of the evaluation process of a company that is not only used for the internal purpose but mainly for the creditors and the investors who explore for better profit marginsProfit MarginsProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. .
How to Calculate Return On Sales?
The calculation of return on sales ratio is done by dividing the operating profit by the net sales for the period, and it is mathematically represented as,Return on Sales = Operating profit / Net sales * 100%
It is to be ensured that the operating profit does not include any of the non-operating income or expenses such as income tax, interest expense, etc.
The following five simple steps can be used to the calculation of return on sales of a company:
- Firstly, collect operating expensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit. such as rent, equipment, inventory costs, marketing, etc. from the income statementThe Income StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements..
- Next, collect net sales also from the income statement.
- Now, subtract the operating expenses from the net sales to find the operating profit of the company.
Operating profit = Net sales – Operating expense.
- Now, divide the operating profit by the net sales to find the portion of each dollar the company keeps as profit.
- Finally, multiply the above result by 100% for the calculation of return on sales ratio as a percentage.
Return on Sales = Operating profit / Net sales * 100%
Examples of Return on Sales Ratio
Let us consider an example of the calculation of return on sales ratio for a company called PQR Limited. PQR Limited is in the business of manufacturing customized roller skates for both professional and amateur skaters. At the end of the financial year 20XX, QPR Limited has earned $150,000 in total net sales along with the corresponding expenses.
- Net sales: (+) $150,000
- Salaries: (-) $50,000
- Rent: (-) $20,000
- Interest expense: (-) $10,000
- Depreciation expense: (-) $25,000
- Taxes: (-) $4,000
- Net income: $41,000
Based on the given information, the operating profit of PQR Limited at the end of the financial year 20XX can be calculated as,
Operating profit = Net sales – Salaries – Rent – Depreciation expense
[Interest expense and Taxes not included as these are non-operating expenses]
The calculation of Return on Sales Formula can be done as,
Return on sales =Operating profit / Net sales * 100%
Therefore, the Return on Sales Ratio of the company for the year 20XX stood at 36.67
Relevance and Uses
- Every business owner has some definite goals, and one of the chief goals is to make a profit. A business needs money to operate, and therefore it is essential for the business to make an adequate profit so that it can invest more money in the business to make it a continuous process. As such, ROS is used to understand whether the turnover is being converted to actual profit or not, and if it is making a profit, then how much percentage of the turnover is the actual profit after subtracting all the expenses.
- The Return on sales is a very important financial ratioImportant Financial RatioFinancial ratios are indications of a company's financial performance. There are several forms of financial ratios that indicate the company's results, financial risks, and operational efficiency, such as the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratio, stability ratios, and so on. because various stakeholders of a company such as investors, creditors, and other debt holders trust this efficiency ratio since it accurately conveys the percentage of operating profit a company makes on its total sales income. Consequently, it provides insight into potential earning, reinvestmentReinvestmentReinvestment is the process of investing the returns received from investment in dividends, interests, or cash rewards to purchase additional shares and reinvesting the gains. Investors do not opt for cash benefits as they are reinvesting their profits in their portfolio. potential, and the company’s debt servicing ability. A higher return on sales ratio for a company means that the company is performing better because it retains more money as profit. Further, an increasing ROS shows that the company is growing efficiently, while a decreasing trend in the ratio could be an indication of looming financial difficulties.
- ROS is employed in the comparison of current period performance with that of the previous periods. It eventually lets a company carry out trend analyses that help in the comparison of the internal efficiency performance over time. It is also useful in the comparison of one company’s return on sales percentage with that of another competing company, regardless of the scale of operation. In this way, an analyst may find it feasible to compare and assess the performance of a small company vis-à-vis a large company such as a Fortune 500 company.
- The ratio of return on sales should only be utilized in the comparison of companies within the same industry as the ratio varies significantly across industries. For example, a grocery retail chain has a much lower margin as compared to a technology company, and the same trend can be seen for ROS for these industries, and as such, they are not comparable.
This article has been a guide to what is Return on Sales. Here we discuss Return on Sales calculation using its formula (Operating Profit/Net Sales) along with practical examples. You may also have a look at the following financial analysis articles –