Return on sales (ROS) is a ratio that you can use to evaluate a company’s operational efficiency. This measurement provides insight into how much profit is being produced per dollar of sales.
Return on sales measures a company’s management. Do they need to start implementing long-term changes to make them more productive? It helps to demonstrate how efficiently they use their resources and whether or not the company is utilizing their assets properly. An increasing ROS indicates that a company is growing more efficiently, while the opposite implies that there could be some existence of some financial troubles.
Another important point to be remembered is that ROS is only useful when comparing companies in the same line of business and of roughly the same size. ROS is not useful when one wants to compare companies operating in different industries.
Return on Sales Formula
Operating profit in simple terms is defined as gross profit minus operating expenses. Expenses incurred in carrying out an organization’s day-to-day activities, but not directly associated with production are called operation expenses (rent, repairs, taxes, transportation, the salary of employees).
Net sales are the revenue of the company. Technically, net sales are the sum of a company’s gross sales minus returns, allowances, and discounts. If you don’t know the operating profit, you can use the following formula:
An increase in the value of return on sales doesn’t necessarily mean that revenues of the company have to climb – it also reflects operational efficiency. On the other hand, decreasing ROS may be indicative of poor financial management or waste. Companies with a high return on sales can survive minor economic imbalances, economic downturns and, lapses in the sales.
Every business has ‘profit’ as one of its primary and fundamental goals. Universally, every company needs money to operate. They need profits for their existence, and they can reinvest money with the goal of continuous development. To this end, the value of ROS is that it helps them understand whether their turnover is being converted to actual profit or not. Then, if it is making a profit, what percentage of the company’s turnover actually qualifies as profit after subtracting the sum of all expenses.
Return on Sales Example
Mrs. Miller is looking for a company to invest in. The ‘MotorKings’ company produces toy motorcycles for kids between the ages of 8 to 15. The company pays $55,000 in employee salaries. They pay an annual amount of $23,450 in rent and $35,000 to the government in the form of taxes. At the end of the financial year 2019, it has earned $750,000 in total net sales. What would be their return on sales?
While we don’t have the operating profit, we can calculate it using the second formula we learned earlier. From the example, we can gather that their operating expenses would include taxes ($35,000), rent ($23,450), and salaries ($55,000), for a total of $113,450.
Now we can calculate the return on sales:
In this case, the return on sales would be 0.8487, or 84.87%. This is a relatively high ROS, which suggests that the company is doing financially well. They will probably make higher profits for their industry. Based on this one formula, this could be a great investment opportunity.
Return on Sales Analysis
Various stakeholders of a company such as investors, creditors and other debt holders rely on the Return on Sales ratio as the ratio accurately conveys the percentage of operating profit a company makes on its total sales income. A good ROS will buildup confidence for the stakeholders to invest and to work with the company.
Furthermore, you can use this ratio to analyze and asses a company’s success over different years. Similarly, ROS helps in trend analysis. Chiefly, ROS gives companies a way to find the areas where they are under-performing and paves way for them to lay down strategies to build up in the weak areas.
Sometimes, analysts lay too much emphasis on the return of sales without giving much importance to the study of market conditions, which may hurt a company’s strategy. Likewise, you shouldn’t use ROS to compare results from different industries. You cannot compare Company A, which operates in the mobile industry with Company B, which operates in the automobile industry.
Strictly speaking, you should only be using the ROS formula to compare different companies operating in the same industry or market. The results will be too different for an accurate comparison. Lastly, ROS is not a good measure for assessing the conduct of newly incorporated businesses. This is because newly incorporated businesses have a lot of expenditure on promotions, and advertising. In those cases, return on sales would not prove to be a good tool in assessing the quality of working of a company.
Return on Sales Conclusion
- The return on sales evaluates a company’s operational efficiency.
- Higher return on sales indicates higher growing efficiency of a company and vice-versa.
- The concept of return on sales can only be applied to companies that are operating in the same industry.
- You can compare a company’s present performance with that of previous periods using the ROS.
- Return on sales is more accurate for well-established companies.
Return on Sales Calculator
You can use this return on sales calculator to quickly calculate the return on sales value by entering the required numbers.
FAQs
1. What is Return On Sales (ROS)?
The Return On Sales, or ROS, is a financial ratio that measures the percentage of net operating profit a company makes on its total sales income. In other words, it shows how efficient a company is in turning its sales into profits.
2. How do you calculate the Return On Sales (ROS)?
The Return On Sales can be calculated using the following formula: Return On Sales = Operating Profit / Net Sales
3. What is a good Return On Sales (ROS)?
A good Return On Sales is one that is greater than zero. This means the company is making more money from its operations than it is spending. Anything above 1 is considered excellent, and anything below 0 should be cause for concern.
4. What can the Return On Sales (ROS) tell you?
The Return On Sales can tell you a number of things about a company, including How efficient the company is in turning its sales into profits, how well the company is performing compared to previous periods, how it compares to other companies in its industry, and where the company may be underperforming.
5. What are the limitations of Return On Sales (ROS)?
There are a few limitations to consider when using the Return On Sales ratio: The ratio should only be used to compare companies that are operating in the same industry or market, as results will be too different for an accurate comparison; newly incorporated businesses typically have high expenses related to advertising and promotion, which can distort the results of the ratio, and the ratio is not a good measure for assessing the quality of newly incorporated businesses.
