Return on Sales Definition, Importance, Example, Formula & Overview

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Definition: Return on Sales

Return on sales (ROS) is a standard financial ratio used to measure the efficiency with which a company generates profits from its sales. Return on sales is a ratio that captures a company’s operating performance. Return on sales indicates the profit an entity makes after expensing variable costs of production such as wages, raw materials, etc. (but before interest and tax). ROS is expressed as a percentage of revenue.

Revenue is generated and expenses are incurred in any business and this ratio analyzes the performance of the entity by calculating the operating profits as a percentage of total revenue. Since return on sales measures the profitability or profit ratio of the firm, it is one of the profitability ratios along with Return on assets and Return on equity.

Return on sales is also known as the operating profit margin or the operating margin as it gives an idea of the operating efficiency of the entity and communicates the firm's reinvestment potential, ability to repay debt and the probable dividends. Hence, ROS is a measure of both efficiency and profitability of a firm. ROS thus is a major evaluation criterion for internal purposes but also for the investors and creditors who reach out for better profit margins. Return on sales is a useful tool to compare a companies' performance with others and to analyze its performance against its past records. A high ROS indicates high operating efficiency and ability to survive economic downturns, while a dismal ratio is an indicator of potential financial distress.

Return on Sales (ROS)


Importance of Return on Sales (ROS)

Some important aspects of return on sales for businesses are:

1. ROS is an efficient tool that measures the performance of the business and compares it with its past performance and other businesses.

2. The comparison using return on sales makes it easier for emerging businesses to compare themselves with well-established businesses.

3. As current performance can be compared with past performance, this allows the firm to carry out trend analysis and collate its internal efficiency.

4. Creditors, Investors and debt holders of the firm can count on return on sales ratio as it conveys its operating profits and gives an insight into the company's ability to repay debt, any impending financial troubles, its potential dividends, and reinvestment potential.

5. As the ratio is calculated quickly, it is highly valuable for real-time calculation of the efficiency of the firm.

6. The ratio varies over the industry greatly yet in a particular business it can provide relevant insights. A increasing ratio signals increasing efficiency while a decreasing ratio points towards financial troubles.

7. ROS provides management insights on the amount of profit per dollar of sales


Formula for Return on Sales (ROS)

ROS (Return on Sales) = EBIT / Net Sales

or,

ROS = (Operating Profit) / (Net Sales)

where,

EBIT = Earnings Before Interest and Taxes

EBIT = Net Sales - Operating Expenses

Hence, ROS = (Net Sales - Operating Expenses) / Net Sales


Example of Return on Sales

Lets ABC Restaurant generates annual revenue of $ 70,00,000 from sales. It incurs an operating expense of $ 20,00,000 before any interest or taxes every year. Hence, to find the Return on Sales, first, the operating profit or EBIT has to be calculated.

EBIT = Net Sales - Operating expenses

Since , Net Sales = $ 70,00,000 and

Operating expenses = $ 20,00,000

Hence, Operating Profit (EBIT) = $ 50,00,000 (70,00,000 - 20,00,000)

Now, Return on Sales (ROS) = EBIT / Net Sales

Return on Sales (ROS) = 0.175 or 17.5 % (50,00,000 / 70,00,000)

Hence, it can be seen that only 17.5 percent of the sales revenue is converted to profits. In other words, 82.5 percent of the sales revenue is used to run the business. The profitability and efficiency can be increased by decreasing the expenses or increasing sales.

Hence, this concludes the definition of Return on Sales along with its overview.

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