Sales is a crucial part of any business. By measuring it, you can gauge the health of the business and assess your marketing plans. It also gives an idea about the company’s budget and how it can be manipulated for the next quarter or year for optimal profits.
The success of any company’s sales team can be judged by checking its return on sales (ROS). There is a return on sales formula that can accurately determine how good or bad your sales situation is. Although it may seem that checking the sales performance of a big company is a tough and tedious task, there is but a simple and scientific way to determine the sales ratio.
Any marketing or sales professional must be aware of the ROS formula and its application in the practical field. In this article, we will tell you all about return on sales, including its definition, formula, calculation methods, its needs and benefits, examples, as well as its comparison with other metrics.
First, let us tell you what return on sales is and how it is determined.
What is Return on Sales?
Return on Sales is based on a simple metric. It is displayed as a percentage or ratio of the overall revenue earned by the company in profits to the operating and maintenance costs. This simple calculation comprises the ROS definition.
Basically, return on sales can be calculated by measuring how much your company has earned via sales versus how much it has spent in various areas. The aim of the sales team should be to drive up the sales ratio because it indicates more profit.
Tracking the ROS data is important for all organizations as it gives a clear picture of the company’s performance and also helps to evaluate their future strategies. It also highlights the areas that are performing well, along with the strategies or expenses that are costing the company too much.
Since ROS is so important to calculate, let us dive into how we can get an accurate sense of the ROS calculation.
Return of Sales Formula and How to Calculate It
Return on sales can be calculated in the form of a ratio or a percentage. Either way, it gives an accurate idea of the company’s profit margin. Return on sales calculation can be done through the following formula:
ROS = (Revenue – Expenses) / Revenue
Through this formula, the ROS comes in the form of a percentage. You can also choose to keep it as a ratio for better understanding, if required.
All you have to do is figure out the exact revenue your company has earned in a period of time. Along with it, you also need to know the exact operating costs of the company, which includes all expenses and liabilities. Once you get an accurate number for both situations, it is very easy to calculate your company’s return on sales.
Examples of ROS Calculation
Once you get the hang of the concept and formula, it is very easy to calculate the actual ROS of any organization. Here, we will show you a couple of examples of how to execute the calculation successfully.
For instance, let’s assume that a business earns $600,000 in sales in a quarter. In the same time period, their expenses reached $300,000. Now, you have to calculate their ROS in this scenario.
For that, first, you have to calculate the net profit earned by the company. To do that, subtract the expenses from the total revenue, i.e., $600,000 - $300,000. Hence, the profit figure is $300,000. Now, you must divide the profit by your total revenue, which is $600,000.
This gives you the ROS, which is 0.50. If you want to display the ROS as a percentage, just multiply 0.50 by 100, which in this case would be 50%. This figure represents that your company will make 50 cents in profit for each dollar they earn in sales. This figure comes after taking into account all the expenses that go into maintaining the company’s business and services.
In another instance, let’s consider that a company makes sales of $100,000 in a quarter. Their expenses in this quarter come up to $20,000. To calculate the ROS for this company, we will use the same formula.
The net profit of the company will be $100,000 - $20,000, i.e., Revenue - Expenses. Hence, the profit is $80,000. Divide this figure by the total revenue to get the ROS. Hence, it will be $80,000/100,000, which is 0.80 or 0.80 * 100, which is 80%.
In this case, the company makes 80 cents in profit for each dollar they earn by selling their products or services. Hope these examples make it clear how to calculate ROS for any organization.
Now, the question arises, why at all would anyone want to calculate ROS, and how would it benefit the company or the sales team?
Why Should You Calculate Return on Sales?
Now, it is abundantly clear that ROS gives you the easiest way to determine a company’s overall performance in a quarter or year. But, why would you need to calculate that amount? Here’s why.
- Often, investors or stakeholders want to get a clear idea of how the company is performing in terms of revenue. Calculating the return on sales gives them an insight into where their money is going and how much they are likely to earn from this investment.
- ROS gives an idea about the financial situation of the company and its reinvestment potential. You can also figure out whether the company is able to pay back its loan or dividends or give a profit sum to its shareholders.
- It is also a reliable way to measure the yearly or quarterly performance of an organization. In this case, merely measuring the sales figure will not be enough. It may so happen that with increasing sales, the costs of the company also increase, and the net profit decreases. To get a wholesome idea, it is essential to measure the ROS, not just the revenue.
- Return on sales measures both the revenue and the expenses, to help us understand the relationship and interaction between the two figures. With this, you can understand how the company is actually performing and whether all its resources are being utilized optimally.
- You can also compare the ROS of two different companies to assess how they are performing in the same field. It gives you a healthy idea of your competition and how you need to improve your strategies to increase performance. However, this comparison only works with companies belonging to the same industry, as ROS standards might vary greatly with respect to a specific industry.
Return on Sales Versus Other Metrics
Return on sales has a correlation with a few other metrics in the revenue world. Let’s look into a few of those.
The net profit margin is a ratio comparing the net profits of a company to its sales. It is sometimes equal to the ROS as both are ratios that determine the average profit earned based on the average revenue spent. The differences may lie in the specific inputs that are considered to calculate the amount.
The net profit margin can be calculated by dividing the net profit that a company earns, after deducting the taxes and other expenses that have to be paid. For example, if your company earns a profit of $100,000 after paying taxes and earning sales of $50,000, its net profit margin would be 2 or 200%.
The net profit margin helps companies to assess how their performance has been during several time periods. This way, you can calculate the performance of the past and how the figures have improved over time.
Return on Equity (ROE)
Equity refers to the difference between the assets and liabilities of a company. Return on equity (ROE) is the measure of what you will get back from the company in return for your investment.
For example, if your company’s equity is $200,000 and the total profit is $100,000, your ROE will be $100,000 divided by $200,000, which is 0.5. This means, for each dollar they earn in revenue, they retain 50 cents after expenses.
Return on Assets (ROA)
Return on assets (ROA) helps you to determine how efficiently the assets of the company are being used to generate profit. If your company owns an asset, it is reflected in its total equity. In case a company does not owe any debts, the ROE and ROA will be equal. With increasing debts, the ROA will decrease.
For example, if a company has total assets of $300,000 and a net income of $500,000, the ROA will be $300,000 divided by $500,000, which is 0.6. This means that for an asset of one dollar, the company generates a profit of 60 cents.
Return on Capital Employed (ROCE)
ROCE is a financial ratio that determines how much a company earns in profit versus the efficiency of the applied capital. This means that return on capital employed can be calculated by determining the earnings of a company before interest and taxes(EBIT), and dividing that figure by the total capital employed.
The capital employed can be determined by subtracting the current liabilities from total assets. For example, if a company’s EBIT is $500,000, and its capital employed is 1,000,000, the ROCE will be EBIT / Capital, which is 0.5 or 50%.
It is necessary to measure a company’s profits, investments, and sales to get a quantitative idea of its performance. Return on sales and its associated formulas and other metrics help all stakeholders in a company to get an accurate idea of where the money is going and how much. This retains the transparency of a company throughout the years.