Revenue is a key focus for sales.
Generally speaking, the more revenue your sales function generates, the healthier your business will be. You’ll be well-placed to grow your teams, invest in your product, and develop your workforce.
However, revenue is far from the only sales metric you need to be monitoring. You could be generating substantial revenues through sales, but still not turning a profit.
That’s where return on sales comes in.
ROS (return on sales) measures the efficiency with which your sales are turned into profits, providing a valuable insight into how much profit you earn from every dollar of sales you generate. As such, it closely relates to a company’s operating profit margin.
Expressed as a ratio or a percentage, return on sales helps you understand the health of your company. If that percentage is increasing, your business is growing in a more efficient manner, whereas if it drops, the opposite is true – and substantial financial problems could be looming.
ROS can also be an effective way to assess your performance against your competitors. However, if you operate across multiple industries, it’s important to note that return on sales is only a helpful measure for companies within the same industry, as costs can vary widely from one to another. For instance, tech companies typically have low costs – and therefore achieve a very high ROS – while grocers tend to have high costs and lower ROS figures.
Individual financial metrics only ever tell part of the story about the health of your business, and return on sales is no different.
ROS gives you a clear picture of how efficiently sales transform into profits, which in turn tells you:
By tracking ROS over time, you can easily understand whether your business is becoming more or less efficient, and therefore whether you need to tighten your belt or update your processes.
However, return on sales doesn’t tell you whether sales are increasing, where those sales are coming from, or what’s causing any inefficiencies – so as always, you’ll need to do some further digging to get the full picture.
Clearly, ROS is important. You want to run an efficient business, so you definitely want your return on sales to head in the right direction over time. With that in mind, here’s how to calculate it.
The formula is relatively simple:
Now, let’s see how that looks for a business with:
In this instance, we’d start by adding up the different expenses:
Now, we can subtract those expenses from the top line to calculate the return on sales, as follows:
In other words, this business generated a return on sales of 45%, meaning it earns 45 cents from every dollar sold.
That sounds pretty good – generally speaking, a “decent” ROS is anything over 5%. However, if this business happens to be in an industry with extremely low costs and high revenues, it may simply be average (or even below-par).
As we have already noted, return on sales and operating profit margin are tightly intertwined. However, they are not exactly the same.
As standard, operating margin is calculated by dividing operating income by net sales.
On the other hand, ROS is typically based on earnings before interest and taxes (EBIT). Because operating margins can vary widely for companies with different business models and in different industries, it can be confusing to compare them on an EBIT basis.
By this point, you understand how to calculate your return on sales. But what if you find your ROS is lagging behind that of your competitors? That suggests your business is not operating as efficiently as it could be, which means you need to take action. Here are some ways to improve it:
ROS is just one metric you can use to glean insights into the efficiency and financial performance of your business. There are dozens (or even hundreds) of others available, including these three:
Return on sales is a valuable metric that can inform a wide range of actions.
Having calculated your ROS, you might decide to make changes. You might review your prices, increase or decrease the size of your sales force or product team, or reduce your production costs.
These are key decisions that can have a huge impact on the future of your business, so it’s vital you have the necessary data to back them up.