Profitability is a key factor in the long-term success of any company. But how do you measure and improve it? One key indicator is a return on sales.
In this article, you'll learn sales return definition & benefits, how to calculate ROS, and what constitutes a good return on sales ratio. Get useful tips on how to increase this indicator through various strategies and discuss the factors that can impact a company's ROS.
What does return on sales mean?
Return on sales definition: ROS is a financial performance metric that measures the efficiency of a company's sales and marketing efforts. It is calculated by dividing the net profit by total sales and is represented in a percentage.
ROS is particularly relevant for B2B companies, as they often have longer sales cycles and higher expenses due to the complexity of their products or services. By carefully managing costs and maximizing profitability, B2B enterprises can efficiently use return on sales as a critical indicator of their financial health and potential for growth.
Main benefits for a certain period:
- ROS is a useful metric for businesses to track because it helps them understand the profitability of their sales and identify areas for improvement.
- ROS provides a clear and straightforward measure of a company's performance.
- Return on sales considers a company's expenses, which can vary over time. This means that it can provide a more accurate picture of profitability than simply looking at revenue alone.
- ROS is an essential metric for anyone looking to understand a company's financial performance and potential for growth.
ROS & operating return on sales: difference
We know these concepts are sometimes confusing, so let's break them down.
Operating return on sales, also known as operating margin, is a measure of a company's profitability. It is calculated by dividing the company's operating income by its total sales. Operating income is a measure of profitability that excludes certain non-operating spending, such as interest expense and taxes.
In other words, operating return on sales measures the profitability of a company's operations, while return on sales - the company's overall profitability. The two measures can be different if the company has high non-operating costs, such as interest expenses on debt or taxes.
Return on sales as a crucial factor
It’s essential for investors and business partners when evaluating business performance, as it indicates the company's ability to pay loans back, the potential for reinvestment, and potential dividends.
For example, let’s consider two B2B companies:
Company A and Company B. Both generate US$1 million in net sales. However, Company A incurs US$900,000 in expenses to achieve this revenue, while Company B incurs US$600,000.
In this case, Company B has a higher Return on sales because it can generate the same revenue with fewer costs. This means that Company B is more profitable and may be more attractive to potential investors and business partners.
How to find a return on sales?
To make a return on sales calculation for a company, you will need the following info:
- Net profit. This is the company's total earnings, calculated by subtracting its expenses from its revenues.
- Total sales. This is the total amount of money the company has generated from selling its products or services.
How to calculate sales return? Formula & example
To calculate ROS, divide the net profit by total sales and multiply by 100 to express the result as a percentage.
Here's the rate of return on sales formula
ROS = (Net Profit / Total Sales) x 100
If a company had a net profit of US$50,000 and total sales of US$100,000, their ROS would be 50%.
What is a good return on sales ratio?
So we have the result of the formula. How do we know that our result is good? You need to know which coefficient is positive.
A good return on sales (ROS) ratio is higher than the industry average and demonstrates a company's ability to generate profits from its sales. It’s calculated by dividing the company's net income or operating profit by its sales.
Generally, a return on sales ratio of around 10% is considered a good benchmark.
Note. This is just a rough guideline, and the ideal ROS will vary depending on the abovementioned factors.
More indicators/metrics for improving return on sales
Calculating and monitoring not only the ROS but also the cost of sales ratio, marketing return on sales, and target return on sales ratios are extremely important. It can help you better understand your financial performance and identify opportunities for improving profitability.
By analyzing these ratios, you can identify trends and patterns in its sales, expenses, and profitability and make informed decisions about optimizing its operations to increase profitability.
Using this formula you can calculate target return on sales
Target Return on Sales = (Net Income / Sales) x 100
Target Return on Sales = (Operating Profit / Sales) x 100
A company's management typically sets the target return on sales as a goal for the business and can be used as a benchmark for evaluating the business's financial performance. It may be based on factors such as industry benchmarks, the company's past performance, and strategic objectives.
Using a similar formula, you can get marketing return on sales
Marketing Return on Sales = (Marketing Expenses / Sales) x 100
Marketing return on sales refers to the profitability of a corporation's marketing efforts. It is calculated by dividing a company's marketing expenses by its sales. This coefficient can be used to evaluate the effectiveness of marketing efforts in terms of the profits generated.
A high marketing return on sales ratio may indicate that a company's marketing efforts generate a good return on investment. In contrast, a low ratio may indicate that the marketing expenses need to result in sufficient sales.
Using a similar formula, you can get the cost of sales ratio
Cost of Sales Ratio = (Cost of Goods Sold / Sales) x 100
The cost of sales ratio, also known as the cost of goods sold ratio, is a measure of each sale percentage that goes towards the direct costs associated with producing the goods or services that a company sells. COGS includes the direct costs of producing the goods or services that a business sells, such as raw materials and labor.
A high cost-of-sales ratio may indicate that the enterprise is incurring high costs to produce its goods or services, which can reduce its profitability. On the other hand, a low cost-of-sales ratio may indicate that the business is able to produce its goods or services at a lower cost, which can increase its profitability.
What factors can impact a company's return on sales ratio?
Industry benchmarks. Different industries have different profitability standards, so you need to compare a return on sales to the industry average.
For example, a company in the tech industry may have a higher ROS than a company in the retail industry due to the higher margins typically associated with tech products.
Business model. The nature of a company's business can also impact its ROS. For example, businesses that sell high-margin products or services, such as luxury goods or consulting services, may have a higher ROS than companies that sell low-margin commodity products.
Growth prospects. An enterprise with strong growth prospects may be able to sustain a lower ROS, as it is likely to see an increase in sales over time. Conversely, a company with limited growth opportunities may need to maintain a higher ROS to stay profitable.
Comparisons with competitors. Comparing a return on sales ratio to its competitors is also helpful. This can help you understand whether the company is performing better or worse and whether it has room for improvement.
Trends over time. It is also vital to consider trends in ROS over time. If the ROS is consistently declining, this could be a red flag, indicating that the company is struggling to generate profits from its sales.
How to increase return on sales? 10 strategies
There are several strategies that businesses can use to increase their ROS ratio:
- Increase prices.
- Reduce costs.
- Increase sales volume.
- Improve product mix.
- Streamline operations.
- Expand into new markets.
- Introduce new products or services.
- Implement price optimization strategies.
- Improve customer retention.
- Implement marketing and sales strategies.
1. Increase prices = get a good return on sales ratio
By increasing prices, a company can increase its total revenue and improve its ROS. But don't forget to consider market conditions and the potential impact on demand.
One way to increase prices is to review market conditions and determine if it is feasible to raise prices without losing too many customers.
Another approach is introducing premium versions of products or services, which can command higher prices due to added features or benefits.
2. Reduce costs = get a good return on sales ratio
Companies can increase ROS through cost-cutting measures such as streamlining operations, negotiating better prices with suppliers, or automating certain processes.
3. Increase sales volume = get a good return on sales ratio
You can improve ROS with these strategies through marketing and sales efforts such as targeted advertising, upselling, or expanding into new markets.
Ways to increase sales volume include:
- Expanding into new markets or regions
- Offering promotions or discounts to encourage customer purchases
- Implementing targeted advertising or marketing campaigns
4. Improve product mix = get a good return on sales ratio
Improving the product mix involves analyzing the current product offerings and identifying opportunities to increase the proportion of higher margin products in the overall mix.
This can be achieved through various methods, such as:
- Developing and introducing new products or services
- Promoting higher margin products more heavily
- Bundling products or services to create higher value offerings
5. Streamline operations = get a good return on sales ratio
Streamlining operations involves identifying and eliminating unnecessary steps or processes in order to improve efficiency and reduce costs.
This can be achieved through a variety of methods, such as:
- Automating certain tasks or processes
- Using data and analytics to identify bottlenecks or inefficiencies in the current process
- Implementing standard operating procedures to improve consistency and reduce errors
6. Expand into new markets = get a good return on sales ratio
Expanding into new markets involves identifying opportunities to sell products or services to customers in new regions or demographics.
This can be achieved through a variety of methods, such as:
- Conducting market research to identify potential customers or partners in new markets
- Developing marketing and sales strategies tailored to the needs of the new market
- Adjusting products or services to meet the needs or preferences of the new market
7. Improve customer retention = get a good return on sales ratio
Improving customer retention involves keeping existing customers engaged and encouraging them to continue purchasing products or services.
Use methods such as:
- Offering excellent customer service and support
- Developing loyalty programs or rewards systems to incentivize repeat purchases
- Offering personalized recommendations or customized products or services
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Implement marketing and sales strategies
By effectively marketing and selling products or services, businesses can increase their sales volume and improve their ROS.
A variety of methods:
- Developing targeted advertising or marketing campaigns to reach potential customers
- Utilizing social media and other online platforms to reach a wider audience
- Offering promotions or discounts to encourage customer purchases
- Utilizing data and analytics to understand customer preferences and tailor marketing and sales efforts accordingly
- Training sales teams on effective techniques for building relationships with customers and closing deals
- Return on sales is a financial performance metric that measures the efficiency of a company's sales and marketing efforts.
- ROS & Operating return on sales is not the same thing. Operating return on sales measures the profitability of a company's operations, while return on sales - the company's overall profitability.
- To calculate ROS, divide the net profit by total sales and multiply by 100 to express the result as a percentage.
- To find ROS, you will need to gather the necessary financial information. This may include profit and loss statements, balance sheets, and other financial reports.
- Return on sales ratio of around 10% is considered a good benchmark.
- Calculating and monitoring not only the return on sales but also the cost of sales ratio, marketing return on sales, and target return on sales ratios are extremely important. It can help you better understand your financial performance and identify opportunities for improving profitability.
- There are several strategies that businesses can use to increase their ROS ratio: increase prices, reduce costs, increase sales volume, improve product mix, etc.