The return on revenue (ROR) ratio is a measure of company profitability based on its revenue. Companies can use it to compare their net income with revenue. Simply put, the return on revenue ratio is the amount of net income made for each dollar of revenue.
So, for example, if the ROR for the company is 0.4, it means that for each dollar made in revenue, $0.40 of the dollar is net income.
Return on revenue is a very important profitability metric for a company because it shows how well the management team is generating sales and managing expenses. ROR is also called the net profit margin.
Companies use return on revenue ratio to compare their performances over different years. A declining return on revenue is a signal that the expenses of the company are increasing or the revenue is declining. Investors are also very interested in return on revenue since it gives an indication of the efficiency with which the company is making a profit for each unit of revenue.
Major factors that affect the return on revenue ratio include the cost of sales, discounts and promos, product quantity demanded, and market penetration. Businesses which wish to increase return on revenue ratio will make changes to its sales plans, aiming at increasing sales while reducing cost.
Return on Revenue Ratio Formula
The return on revenue ratio is defined as the ratio of net income to revenue. It is the net income divided by revenue. If the revenue increases while the net income decreases, the return on revenue will decrease drastically. Return on revenue will only increase sharply if there is an increase in net income while revenue remains constant. As we have understood from the introduction, an increase in net income with a constant revenue means that the company is reducing costs. The reduction may come as a result of finding cheaper suppliers or developing a new, more efficient process of production.
The net income is obtained by subtracting all the expenses associated with the sales from the revenue. For retail companies, the revenue is the money made from the sales of goods minus returns, discounts and promos. For companies or firms that provide services, the revenue is the money made from providing services. It should also be noted that for the purpose of calculating return on revenue ratio, revenue and net income are only calculated from the money that comes from the core activities of the business. If there is extra cash or income that does not come from the core activity of the business, the income should not be included in calculating the return on revenue.
Return on Revenue Ratio Example
A bathroom slippers manufacturing company, slipon has prospective investors who are asking for slipon’s return on revenue ratio. For the past year, slipon had manufactured and sold 4,380 cartons of bathroom slippers at $72 per carton. The cost of distributing the slippers to the buyers was $1,450. The total cost of manufacturing and packaging the slippers was $56 per carton. Administrative costs for the past year was $29,000. However, slipon also had an income of $30,000 from an investment they made in another company. What is the return on revenue ratio for slipon?
First, let us get the data that is required to calculate the return on revenue ratio. From our formula, we need to know the net income and revenue.
We need to calculate for each of the variables separately. Since net income is the difference between revenue and expenses, we need to calculate the revenue first. To calculate the revenue, you simply multiply the number of products sold (4,380) by the cost per item ($72). So, the revenue for the past year was $315,360. There were no returns for the slippers sold.
To calculate the net income, we need to find the difference between revenue ($315,360) and expenses ($245,280 + $1,450), so the net income is $68,270. Now let’s pull together all of our variables.
- Return on revenue ratio = unknown
- Net income = $68,270
- Revenue = $315,360
We can now use our formula:
The return on revenue is 0.22, which means that for each dollar that is made in revenue, the net income on the dollar is $0.22. Notice that the administrative costs of $29,000 and the income from investment of $30,000 was not included in the net income and revenue calculations.
Return on Revenue Ratio Analysis
The return on revenue indicates how much income is made per each unit of revenue. Companies use the return on revenue ratio to compare their year to year performances. If the return on revenue ratio is decreasing over the years, it means that the company is losing its profitability. It is no longer making profit as in the previous years. The reason could be the increase in the cost of production of goods or inefficiency in the manufacturing process.
An increasing return on revenue is an indication that the company is maximizing its income per unit of revenue. Investors are also interested in return on revenue ratio because it tells them how much a company is making as profit per unit of revenue.
The major catch is that return on revenue only gives an indication of the financial performance of a company and not its financial position. This is because it does not take into account the assets or liabilities of a company. It should, therefore, be used in conjunction with other metrics to determine the true position of a firm.
Return on Revenue Ratio Conclusion
- Return on revenue ratio is a profitability measure that shows the profitability performance of a company.
- This ratio shows the fraction of unit revenue that is net income.
- The formula requires two variables, net income and revenue
- Companies with increasing return on revenue are attractive to investors because they show that the company is maximizing its income per revenue.
- Return on revenue should be used in conjunction with other financial metrics as it does not give the true financial position of a firm, but rather a financial performance.
Return on Revenue Ratio Calculation
You can use the return on revenue ratio calculator below to quickly calculate the return on revenue ratio of a company by entering the required numbers.
FAQs
1. What is a Return On Revenue (ROR)?
Return on revenue (ROR) is a profitability measure that shows the performance of a company in terms of how much income is generated from each dollar of revenue. It is used to compare year-on-year performances and investors are interested in it because it tells them how much a company makes as profit per unit of revenue.
2. How is the Return On Revenue (ROR) calculated?
The return on revenue ratio is calculated by dividing the net income by the revenue.
The formula is: ROR = net income / revenue
3. Why is the Return On Revenue (ROR) important?
Return on revenue is important because it gives an indication of how profitable a company is with regards to its revenue. An increasing return on revenue is an indication that the company is maximizing its income per unit of revenue and investors are interested in it for this reason. In addition, return on revenue should be used in conjunction with other financial metrics to get a true indication of the financial position of a company.
4. Is ROI the same as Return On Revenue (ROR)?
No, ROI (return on investment) is different from ROR. ROI measures how efficiently a company uses its capital to generate income. ROR, on the other hand, measures how much income is generated from each unit of revenue.
5. What is a good Return On Revenue (ROR)?
Large corporations usually aim for a return on revenue of 10-15%. Small businesses, on the other hand, might be happy with a 5-8% ROR. It is important to remember that there is no one-size-fits-all answer to this question as it depends on the individual company and its goals.
