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Table of Contents
- What is Return on Sales?
- When to use the ROS ratio?
- When not to use Return on Sales Calculator
- How to calculate Return on Sales?
- Return on Sales formula
- What is a good return on sales?
- The advantages of ROS indicator
- The disadvantages of ROS
- Factors that impact return on sales
- Calculate ROS regularly to optimize net profit.
- Alternative financial metrics to ROS
What is Return on Sales?
Return on sales is a ratio of operating profit to net sales, showing how efficiently the company generates profits from its sales. The higher the ROS coefficient is, the higher income company generates per dollar of sales.
When to use the ROS ratio?
Many performance metrics can be derived from a company's income statement so that anyone can be easily confused by a variety of gauges.
This article will explain when you should analyze ROS and when it would be better to apply alternative metrics.
Return on Sales is most commonly used to:
To determine profitability
Simple ROS percentage can give you a quick overview of a company's profitability. Especially for the companies that depend on regular sales of goods and services.
To determine efficiency
Although, a positive ROS value is a good sign of a profitable company. The most crucial factor is the level of return on sales value. The higher the ratio, the higher the profits.
To compare companies
ROS is a good metric for the comparison of different companies. However, you should remember that comparing companies from different industries and sizes is not recommended.
To compare periods
Comparing the company's efficiency on different timeframes is the best and most accurate usage of the return on sales ratio. Since the cost structure and business model stay the same, you can be sure that your analysis will drive you to the right conclusions.
To identify companies with high costs.
For businesses with significant turnover but low or even negative ROS value, it is a clear sign of not optimal cost structure. If the return on sales decreases with higher turnover, you should look for opportunities for cost reduction.
When not to use Return on Sales Calculator
As we mentioned earlier, ROS is not the right tool for comparing companies with entirely different business models or different sizes.
High contrast in the structure of the costs between them will make such a comparison misleading. There is no easy shortcut for benchmarking vastly different investments, and you should opt for a more in-depth analysis rather than looking for just one or two variables.
- Return on Sales is a company's operating profit ratio to its net sales.
- Net sales are total revenue minus debt (and refunds to customers)
- ROS answers the question of how much-operating profit is generated for each dollar of sales.
- Businesses different in size, business model, or industry should be compared using alternative metrics.
How to calculate Return on Sales?
Return on Sales formula
ROS = (operating_profit / net_sales) * 100%
- Since the companies do not always generate profits. Return of Sales may take positive or negative values.
- Operating profit may be expressed as revenue - costs, so ROS can be increased by reducing costs.
Some investors prefer using EBIT (Earnings Before Interest and Tax) instead of operating profit in calculations. Visit our EBIT calculator for more details.
What is a good return on sales?
For most companies, ROS above 5% is considered good. In 2019 the average Return on Sales of the S&P 500 was 7.8%
Much, of course, depends on the industry because each industry has its specificity. For example, in 2021, Apple reported a 29,8% return on sales, which is much higher than the SP500 average but common among tech giants.
However, it's important to note that even positive ROS doesn't automatically mean that a company is profitable since there are many costs that are not analyzed by this factor. For example, expenses related to investments or interests are not included.
The advantages of ROS indicator
The most important advantage of this financial ratio is its simplicity. It allows us to compare companies in just a few seconds. Rather than just comparing sales revenue or net income, it is more accurate to calculate and compare ROS.
Return on sales allows us to compare the performance of a single company over time by analyzing this metric for different periods. If this profitability ratio increases, your company is better at converting sales into profits.
The disadvantages of ROS
As we mentioned before, return on sales may be misleading if companies have different business models or different structures of the costs.
Analysis of such companies by comparding the ROS values is not the right approach and may lead to wrong conclusions.
Factors that impact return on sales
There are several aspects that affect the return on sales and can be divided into two groups of factors: internal and external.
External forces that impact a company's return on sales constrain the maximum possible value of ROS. The most important ones are:
- Competition, since the intense competition, puts pressure on price decrease or higher marketing spending.
- Market trends may be a strong force that shapes the company's prospects. Trending and growing industries can pump a big influx of sales at a low cost, while outdated niches may lead to the opposite situation.
Internal causes that may impact ROS are the company's costs (especially COGS) and turnover. Since the company has more control over those parameters, there are ways to optimize them and increase the performance of the sales and so profits.
Calculate ROS regularly to optimize net profit.
If you want to improve the net profit margin of your company, you could apply the following tips to increase operational efficiency.
Reduce costs of labor
Some industries require a large number of employees in order to grow. Especially at the beginning, when the employment is low - each new worker can bring an increase in the company's output.
Over time each new worker has less and less impact on the company's operating income, and more can be achieved by increasing the performance of current employees rather than by increasing the number of hired people.
Automation lets you achieve more with the same or lower number of workers. There are different forms of automation, some of them completely replace the workers, and the other makes the work more efficient, so there is no need for high employment, and operating expenses can be lower.
In commerce, the return on sales can be significantly increased by negotiating the costs of goods sold (COGS). For the retail and wholesale industry, it is the highest cost. Any decrease in COGS leads to an immediate increase in operating margin, so it should be optimized with the highest priority.
Cancel not profitable product lines
Sometimes it's better to abandon some market segments rather than run into intense competition to increase turnover at a very high cost.
Even a higher gross profit margin does not always translate to higher operating income if higher revenue leads to higher operating costs.
Alternative financial metrics to ROS
In some cases, it's better to analyze different metrics. In Calcopolis, you could find more specialized tools like ROE calculator or ROCE calculator. For more general cases, you can also use the ROI calculator.