Return on sales

What is return on sales (ROS)?

Return on sales (ROS), often referred to as net profit margin or net margin, is a crucial financial metric. It is pivotal in assessing a company's proficiency in translating sales revenue into actual profit. 

This ratio offers a precise percentage that reflects the portion of each dollar generated from sales, which ultimately translates into net income after accounting for all incurred expenses.

In essence, ROS indicates a company's operational efficiency and profitability. It serves as a valuable gauge for business owners to evaluate the effectiveness of a business in managing its costs and resources.

How to calculate return on sales revenue (with example)

Return on Sales (ROS) is a metric that gauges the effectiveness of a company in converting sales revenue into profits. This is determined by dividing the operating profit by the net sales. Operating profit is the earnings before accounting for interest and taxes (EBIT), while net sales refer to the total revenue after deducting any refunds or credits issued to customers.

The ROS can be calculated using the following formula:

ROS = (Operating profit/Net sales) * 100

Let’s take an example to understand this:

1. A company spends $50,000 on operating expenses.

2. Net sales of the company is $200,000 in a specific period.

3. To calculate the ROS, we first subtract the net sales by the operating cost.

Operating profit = Net sales - Operating cost

Operating Profit = $200,000 - $50,000 = $150,000

4. Now that we have operating profit, we divide it by net sales

$150,000/ $200,000 = 0.75

5. Now, we multiply it by 100 to get the ROS.

ROS = 0.75 * 100 = 75%.

This indicates that the company generates 75 percent of operating profit for every sales dollar.

Benefits of return on sales

The calculation of Return on sales (ROS) provides businesses with critical insights into their financial statements, serving as a compass for informed decision-making aimed at improving profitability. This key metric is pivotal in strategic planning, offering a clear perspective on potential areas for cost reduction and revenue enhancement areas. By leveraging ROS, companies can pinpoint strategies to fortify their financial performance.

Conveys operating profit

Return on Sales (ROS) is a cornerstone metric utilized by a broad spectrum of stakeholders, including creditors, investors, banks, and business analysts. This metric holds a trusting reputation for its precision in delineating the true profitability of a business. Essentially, ROS reveals the proportion of operating profit a business accrues relative to its total sales revenue. This provides invaluable insights not only into the earnings potential of the business but also sheds light on its capacity for growth and overall company performance. Moreover, ROS offers a discerning view into the business's ability to reinvest profits for further development and effectively service debts.

For example, consider a retail company that recorded $1 million in sales revenue for the fiscal year. After accounting for all operational expenses, the company garnered an operating profit of $150,000. They find that their ROS is 15% by applying the return on sales formula. This indicates that the company retains 15 cents as operating profit for every dollar generated in sales.

The Return on Sales (ROS) metric offers a transparent measure of a company's proficiency in producing profits from its principal operations. It presents stakeholders with invaluable data to assess its financial vitality and prospects for enduring growth. Additionally, ROS is instrumental in guiding strategic choices focused on maximizing profitability and the efficient distribution of resources.

Efficient resource allocation

Return on Sales (ROS) proves instrumental in guiding businesses toward effective resource allocation. By scrutinizing this metric, businesses streamline costs and identify  avenues for maximization of a company’s profitability. This empowers companies to make informed decisions on their core operations, optimizing operational efficiency and enhancing overall profitability.

Additionally, the ROS ratio acts as a compass for businesses lost at sea, steering them towards strategies that promise the highest returns on investment, ultimately contributing to sustained financial health and success.

Effective budgeting

The insights derived from Return on Sales (ROS) play a pivotal role in crafting budgets that are not only realistic but also comprehensive in their approach. By considering revenue targets and cost structures, businesses can create financial plans aligning with their operational capacities and market dynamics. 

This ensures that budgets are well-balanced and reflect the company's performance potential. ROS-driven budgeting allows businesses to set achievable revenue goals while focusing on managing costs, ultimately fostering financial stability and sustainable growth. This strategic approach to budgeting enables businesses to navigate the market confidently, positioning them for long-term success.

Risk mitigation

Understanding the relationship between sales and expenses equips businesses with the foresight to proactively recognize and address potential financial vulnerabilities. This strategic insight enables organizations to predict changes in their financial status and implement prompt actions to protect their economic stability. 

By closely monitoring the balance between revenue generation and expenditure management, businesses can implement pre-emptive strategies to address any emerging financial challenges. This bolsters economic resilience and positions the company to adapt swiftly to changing market conditions, ensuring sustained profitability and stability in the long run. This foresight-driven approach empowers businesses to navigate the complex financial landscape with confidence and agility.

Return on sales vs return on investment

Return on investment (ROI) is a financial metric that gauges the gross profit margin a company garners from its invested capital, showcasing the percentage of return generated from its assets or projects. ROI is alternatively referred to as return on assets (ROA) or return on capital employed (ROCE). 

The formula for return on equity

ROI = Net profit/ Cost of investment*100

Although related, return on sales (ROS) and return on investment represent distinct concepts. While ROS quantifies sales profitability, ROI assesses investments' profitability. It is plausible for a company to exhibit a higher return on sales but a low ROI, and vice versa, contingent on its resource allocation and cost management.

For example, to understand this:

•  A company spends $50,000 on operating expenses.

•  Net sales of the company are $200,000 in a specific period.

• The company invests $500,000 in its assets or projects

• The net income generated from this investment is $50,000.

ROI= (50,000/500,000) * 100 = 10%

This means that the company earns 10 cents of profit for every dollar of invested capital.

Return on sales vs return on equity

Return on equity (ROE) is a financial metric that evaluates the profitability of a company concerning the investment made by its shareholders. It represents the percentage of return generated by the company's owners or investors based on their equity stake. ROE is alternatively referred to as return on net worth (RONW) or return on shareholders’ funds (ROSF).

The formula for return on equity

ROE = Net income (annual) / Shareholder’s equity.

Although both return on sales (ROS) and return on equity (ROE) are essential metrics, they assess different aspects of a company's financial performance. ROS gauges the profitability of sales, while ROE evaluates the profitability of equity. Depending on how a company funds its operations and allocates earnings, it can have a high ROS and a low ROE, or vice versa.

Consider our previous example, in which a company with an operating cost of $50,000 and a sales revenue of $200,000. In this scenario, the ROS would amount to 75%, as calculated earlier. However, if the company's shareholders' equity stands at $100,000, the ROE would be:

ROE = $150,000/ $100,000 = 1.5

Return on sales vs operating margin

Operating margin, also known as operating profit margin or EBIT margin, is a financial metric that gauges a company's efficiency in converting sales revenue into operating income. It reveals the percentage of revenue that translates into operating income after accounting for all operating expenses. It's important to note that the operating margin and the Return on Sales (ROS) share similarities but aren't synonymous. 

The Formula

Operating Margin = Operating Income/ Revenue

While ROS assesses sales profitability after deducting all expenses, the operating margin focuses solely on operating expenses. These expenses encompass the cost of goods sold (COGS), general and administrative (SG&A) expenses, depreciation and amortization, as well as research and development (R&D) expenses. Non-operating costs like interest and income taxes are excluded from the calculation.

Now, let’s plug the formula into the example discussed earlier.

• Operating Income = Net Sales - Operating Cost

• Operating Income = $200,000 - $50,000 = $150,000

• Operating Margin = (Operating Income / Net Sales) * 100%

• Operating Margin = ($150,000 / $200,000) * 100%

• Operating Margin = 75%

The operating margin for this example is 75%.

How to increase return on sales

There are two primary approaches to enhancing return on sales: boosting sales revenue or reducing expenses. Here are some strategies to help your business accomplish these objectives:

1. Increase new sales

One of the most straightforward approaches to boosting sales revenue involves attracting new customers and broadening market share. This can be achieved by:

• Tailoring products or services to align with your customers' needs to surpass their expectations and requirements.

• Cultivating a robust brand identity and reputation that sets the company apart from its rivals.

• Executing impactful marketing and promotional tactics that engage and convince prospective customers.

• Furnishing outstanding customer service and support to retain and gratify current clientele.

2. Find opportunities with customers

Enhancing sales revenue can also be achieved by seizing opportunities to upsell or cross-sell to existing customers, which not only increases their loyalty but also amplifies their lifetime value. Additionally, focusing on retaining longstanding customers is a pivotal strategy for sustaining revenue growth. A study by Bain and Company shows that by retaining even 5% of customers can improve revenue by 25%. This can be achieved through:

• Presenting complementary products or services that enhance the value of the customer's purchase.

• Providing discounts, incentives, or rewards for repeat purchases or referrals.

• Establishing loyalty programs or memberships that foster customer retention and active participation.

• Seeking customer feedback and reviews and leveraging them to enhance product or service quality and overall customer satisfaction.

3. Increase the price of the product/service

A third method to boost sales revenue involves increasing the price of the product or service, provided that demand remains relatively inelastic and customers are amenable to paying more. This can be achieved by:

• Articulating the value proposition and advantages of the product or service to validate the price adjustment.

• Stratifying the market and presenting various pricing alternatives tailored to distinct customer segments based on their requirements, preferences, or price sensitivity.

• Bundling or packaging multiple products or services and providing them at a discounted rate.

• Instilling a sense of urgency or scarcity by restricting the availability or supply of the product or service.

Have a well-structured sales commission plan

One of the valuable methods to curtail expenses revolves around implementing a well-structured sales commission plan. This plan not only motivates and incentivizes the sales team but also plays a critical role in augmenting the return on sales. An effective sales commission plan should contain the following attributes:

1. It is imperative that the sales commission plan is straightforward and easily understandable. This ensures that the sales team clearly understands how the compensation is calculated and the actions required to enhance their earnings.

2. The sales commission structure should seamlessly dovetail with the overarching goals and strategies of the company. By doing so, the sales team will be directed towards activities and metrics that contribute directly to bolstering the return on sales.

3. A reasonable commission plan should balance fairness, competitiveness, and adaptability. This empowers the sales team, fostering a sense of value, appreciation, and the impetus to deliver exceptional performance.

4. Regular reviews and adjustments of the commission plan are essential. This practice ensures that the sales team remains motivated and can acclimate to the ever-changing market dynamics and customers' evolving needs.

By adhering to these principles, businesses can reduce expenses and fortify their return on sales, ultimately contributing to a more robust bottom line.

Align sales-marketing

Another pivotal approach to curbing expenses involves aligning the sales and marketing teams to ensure seamless collaboration and efficiency. When sales and marketing teams work in silos, it can impact the entire sales and marketing funnel. As per MarketingProfs, organizations with synchronized sales and marketing teams witness a 38% increase in sales win rates and a 36% surge in customer retention rates.

When orchestrated effectively, a harmonized sales-marketing team can yield many benefits, including:

1. The creation of pertinent, captivating content, campaigns, and offers, after taking pointers from the sales team on customers' pain points, is a huge necessity. A well-aligned team can amass a greater number of high-quality leads and prospects. This equips the sales team with a more fertile ground for conversions.

2. The provision of uniform, personalized messaging, information, and support across the buyer's journey substantially heightens the conversion rate. This, in turn, translates into an augmented closure rate, culminating in a streamlined and efficient sales process.

3. By leveraging data-driven insights and feedback, a harmonized sales-marketing team can strategically optimize the allocation of the marketing budget and the selection of channels and tools. This judicious resource allocation leads to a reduction in both the cost per lead and the cost per sale.

4. Beyond the sale, a well-coordinated team can bolster the customer experience by offering value-added services, educational resources, and consistent communication. This post-sale engagement fortifies customer loyalty and lays the foundation for long-term relationships.

By adopting these strategies, businesses can effectively manage expenses while fortifying their sales efforts concurrently, leading to a more prosperous and sustainable operation.

How to use ROS to increase sales

Return on sales serves as a measure of performance and a valuable tool to enhance a company's sales performance. A thorough analysis of the return on sales ratio can help a company:

1. Discern its areas of strength and areas that require improvement in terms of profitability and operational efficiency.

2. Gauge its performance against industry competitors or established benchmarks, gaining critical insights into its relative standing.

3. Establish practical, attainable goals and targets for advancement, providing a clear roadmap for progress.

4. Continuously monitor progress and assess results over time, allowing for timely adjustments and refinements to strategies and operations. This iterative process facilitates ongoing improvement and sustains competitiveness in the market.

Wrap up

Return on Sales (ROS) is a crucial financial indicator that measures the proportion of profit a company generates from its sales revenue. It measures the company's effectiveness in controlling operational expenses and optimizing its profit margins. 

Implementing an effective CRM solution is crucial in optimizing business performance. A robust CRM system streamlines customer interactions, refines sales processes, and enables data-driven decision-making. By harnessing the power of a comprehensive CRM solution, companies can strategically enhance their return on sales, ultimately bolstering their financial health and competitive edge in the market.