Return on Sales Formula: How to Calculate ROS + Examples
Return on sales measures a company’s operational efficiency. It indicates how much revenue becomes profit relative to how much is required to cover operating costs.
The higher a company’s ROS, the more profitable they are.
The ROS figure also provides valuable data to investors who want to know how efficiently their money will be used.
In this article, we’ll go over everything you need to know about return on sales, including how to calculate it, why it’s so important, and how to use ROS data to improve operating efficiency.
Here’s what we’ll cover:
- What Is Return on Sales (ROS)?
- Return on Sales Formula
- Examples of How to Calculate Return on Sales
- Why Is Return on Sales Important?
- How to Use Your Return on Sales Ratio
- Return on Sales vs. Profit Margin
- What Is a Good Return on Sales?
What Is Return on Sales (ROS)?
Return on sales (ROS) is a ratio that reflects how much profit is earned per dollar of revenue. The number is usually expressed as a percentage and is also sometimes known as operating margin, EBIT margin, operating profit margin, or operating income margin.
The higher a company’s ROS, the more efficient they are with their revenue versus their operating costs.
Return on sales is a direct indicator of how efficient and how profitable a company is; many investors use this number to determine how confident they can feel about how their money is spent.
An increasing ROS over time indicates a company that is either earning more revenue or decreasing their operating costs (or both). A decreasing ROS, on the other hand, could spell financial trouble in the near future.
In short, ROS measures how efficiently a company turns sales into profit.Stay on top of your sales dataDaily activity, engagement data, and outcomes
Return on Sales Formula
The return on sales formula is relatively straightforward. Simply divide your operating profit by your net sales, and multiply that number (it will be less than one) by 100. This shows your ROS in percentage form.
Although the formula is simple, it’s important to make sure you’re inputting the correct figures. A company’s operating profit, in particular, can sometimes be misdefined and improperly reported.
Operating profit can be found by subtracting your expenses, like cost of goods (COGS) and operating expense (SG & A), from your revenue.
The operating profit figure represents a company’s earnings before interest (EBIT). This figure does not take into account taxes or interest expense, because they are not technically operating expenses.
Be careful, though — EBIT is also different from EBITDA, which includes depreciation and amortization. Those two components are excluded from operating profit.
Usually, you can find EBIT data on a company’s income statement.
It’s important to use accurate operating profit data when you calculate ROS. This is the information investors need to get an accurate sense of a business’s operating cash flow.
Examples of How to Calculate Return on Sales
Once you’ve located the right data, calculating return on sales is simple and straightforward. Simply plug the numbers into the formula and determine your ROS percentage.
Let’s look at a return on sales example:
A manufacturing company makes 800,000 in sales and incurs 700,000 in expenses. This means that their operating profit is $100,000.
Now, plug that into the formula. Divide 100,000 by 800,000 for a ROS ratio of 0.125. Multiply that by 100 for a ROS rate of 12.5%.
Here’s another example:
A software company achieves $550,000 in sales, and runs $400,000 of expenses. Their operating profit is $150,000.
Divide their operating profit — $150,000 — by their net sales of $550,000. The ROS ratio here is 0.27. When you multiply that by 100, it shows a 27% return on sales.
Another way to think of the percentage is how many cents a company makes in profit per dollar they earn in sales. This software company earns $0.27 in profit for every $1.00 they make in sales.
Why Is Return on Sales Important?
Return on sales can offer a lot of insight into the health of a company.
It sheds light on how well a company manages its revenue as far as using it efficiently for operating expenses, as well as maximizing revenue generation and profit margins.
This data is important for demonstrating the success of your team to C-suite executives and investors. ROS can also help investors understand potential dividends, whether or not to reinvest, and how able the organization will be to repay their debt.
Sales teams can also use ROS to compare their performance against competitors in the same industry. For the most part, this ratio can be used to compare profitability even for companies of vastly different sizes.
Be careful, though, about using it to compare performance across different industries. Some industries have naturally higher profit margins than others, and attempting to use ROS to compare in that scenario would be like comparing apples to oranges.
Finally, ROS can also be a very useful tool for tracking and evaluating a company’s year-over-year (YOY) performance.
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How to Use Your Return on Sales Ratio
Once you know your return on sales ratio, you can use the data to improve your operating performance.
A poor ROS ratio generally indicates at least one of two issues: your team is not generating enough revenue to cover your operating costs, or your team is not being efficient enough with their operational spending.
Teams that want to improve their ROS can work to:
- Improve their close ratio
- Increase their customer LTV
- Increase their contract value
- Decrease their operating costs
At its core, ROS shows how efficiently a company delivers its products to the market. Once you know your current ROS ratio, you can work to deliver products more efficiently.
Return on Sales vs. Profit Margin
Return on sales is often conflated with profit margin, but there’s actually more nuance to it than that.
There are actually three ways that companies calculate data related to profit margin — only one of those is return on sales (also known as operating profit margin). The other two profit margin categories — gross profit margin and net profit margin — are slightly different.
Operating Profit Margin
Operating profit margin is also known as return on sales. ROS is calculated by dividing a company’s operating income, before interest and taxes, by their net sales.
Net Profit Margin
Net profit margin is sometimes known as rate of return on net sales. This figure compares net profits versus sales. It can be calculated by dividing the net profit, after taxes, by the total net value of the sales.
Gross Profit Margin
To calculate gross profit margin, subtract the cost of all goods sold from the value of the sales. Then, divide that difference by the value of the sales.
The gross profit margin figure can be useful as a benchmark for comparing different companies’ performance.
What Is a Good Return on Sales?
In general, a ROS of 5 – 10% is generally considered a healthy return.
That being said, a “good” ROS ratio will ultimately be determined by your industry and market. Market research around industry benchmarks will give much better insight into healthy ROS ranges for your team.
Regardless of your initial ROS, the goal is to keep improving it. The higher your ROS, the more profitable your company is.
As your business grows, your ROS should grow, too. At the very least, it should remain steady. A declining ROS in an otherwise growing business indicates that expenditures are too high.
Have you calculated your team’s ROS yet? What is it? How can you reduce costs or increase revenue to increase your ROS?
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