by shama@camphorsolutions.comIrrespective of the size of your business, you always wish to increase your sales and generate more and more revenue to grow profitable. Whether your business is experiencing higher sales or not, it does not automatically imply that each penny of the money made is in the form of profits. For you to be able to run a successful cooperation, you must analyse your operating costs, sales revenues, and profit margins to assess the financial soundness of your business. In other words, ROS is the greatest and most valuable indicator for determining the performance of your company.
In general, a company with a strong ROS is considered to be growing and with huge expansion prospects in the future. Read further to find out more about the meaning and importance of Return on sales, the method of its calculations, its significance and limitations, and how having an understanding of ROS could help you to understand your current business performance and make wise decisions for the future.
Return on Sales (ROS)
Commonly referred to as operating margin, EBIT margin, operating profit margin, and operating income margin, ROS is a ratio used to evaluate a company’s operational efficiency which provides insight into the sum of profits generated out of each rupee of sale. The ROS so computed is always expressed in percentage.
While a declining ROS may be an indicator of oncoming financial difficulties, a rising ROS suggests a company is boosting efficiency. ROS is directly proportional to a company’s operating profit margin. Return on sales is one of the better measures for evaluating the efficiency and success of your budgeting and sales tactics because it ultimately indicates the extent to which the revenue you make from sales has been converted to profit, compared to operational expenditures.
Operating profit divided by total sales is multiplied by 100 to get the return on sales (ROS) %. ROS is also referred to as operational profit margin since operating profit can be defined as net profit before deducting interest expenses and net income taxes. ROS’s popularity can be attributed to its relatively simple calculation. For instance, Mr. X is in the business of textiles which generates a profit of Rs. 20,000 in revenue while incurring a total of Rs. 4000 while incurring additional operational costs of Rs. 2000.
Thus, operating profits will be = Rs. 20,000 – Rs. 4,000 – Rs. 2000 = Rs. 14000
ROS % = (14000 / 20,000) by 100= 70%
Good Return on Sale (ROS) and Contributing Factors
A decent return on sales might range from 5 to 20% depending on industry statistics, indicating that your company has a solid operational profit margin of at least 5 to 20% on net revenue. Other than this, a good ROS shall depend on the following factors-
Industry Competitors-
Since your business and your business competitors operate under similar conditions and incur similar kinds of costs (labor or material). As a result, if you can obtain a greater ROS ratio, you will be able to surpass your competitors. Industrial Standards- It is a good idea to compare your profit % to those of other organizations in the same sector to establish your profit percentage. So, if the industry average for return on sales is 13%,
achieving a ROS of 17 % would be doable.
Business Trends-
If your sales returns are rising year over year, your business will become more profitable. An improvement of 10%Â in ROS suggests that you are effectively managing expenses andimproving sales.
Importance of Return on Sale (ROS)?
Discloses critical information to stakeholders- Return on sales (ROS) is an important metric that stakeholders use to assess a company’s operational effectiveness and margin of net profit. It assists investors and creditors in determining a company’s capacity for dividends, reinvestment, and loan repayment. Stakeholders can assess reinvestment possibilities and improve business procedures by using the important data which can be gathered through ROS calculation.
A Valid Metric for Comparison-
Since higher revenues may not be the best measure of a company’s profitability because a company’s costs and revenue may change over time. On the other hand, ROS facilitates analysis of recurring patterns and internal productivity and is used to determine if turnover is converted to gross profit. Thus, businesses consider the ROS ratio as one of the most dependable metrics to analyze their annual performance.
Indicator of Business Growth and Profitability-
The ROS indicator serves as a benchmark for gauging company performance over time and enabling trend analysis and prospective reinvestment. It keeps track of successes and disappointments, offering perspective and perspective on financial difficulties. While a declining ROS indicates prospective financial challenges, a growing ROS implies effective expansion.
Monitors Production Efficiency-
Using ROS further allows you to assess how efficiently the business manufactures its primary products and or delivers services as a good ROS ratio signifies effectiveness and financial success, and if your business has a lower or declining ROS, it may indicate difficulties in business production and find out a solution accordingly.
Ways to increase ROS for your Business
The only method to enhance your return on sales is to increase the difference between your income and the cost of producing your goods, which could be fulfilled in the following ways-
Increase your order value-
A crucial KPI for eCommerce is the average order value. It displays the typical amount a customer spends or is ready to spend while purchasing your products or services, which logically means that if you can raise your average order value you will gain more sales revenue. Furthermore, it ought to slightly lower the price of each order’s shipping and packaging. Thus, to increase the average order value, you should consider strategies to persuade clients to add more items to their basket or select more expensive options.
Raise prices for higher sales value-
Raising pricing is one of the most basic ways to boost your ROS. It could be really effective to increase your sales revenue but doing it correctly requires careful consideration and market research. If your product or services are overpriced you are at risk of damaging your market position or alienating your customer base, leading you to end up with even lesser income and even lower return on sales.
Work on improving your vendor relations-
Making an effort to improve relations with suppliers is an excellent way to cut costs without sacrificing quality of service or return on investment for your company. Proactively request discounts on goods sold and operational supplies, aiming to increase profit margins. Persuade suppliers to accept expensive dead stock and consider alternative vendors if not accommodating.
Discounts and cost reductions for material/product inventories-
This method focuses on another part of the return on sales i.e., your expenses. Although it’s a lot simpler to say than do, continually seek discounts that can drastically lower the cost of production without hurting your revenue stream.
Difference between ROS and ROI
Return on investment (ROI), as the name implies, is a valuation metric used to quantify an investment’s return to a shareholder. It is figured out by taking the product of Net Income/Investment Cost or Investment Gain/Investment Base. It can also be determined by dividing Net Investments by Earnings Before Interest and Tax (EBIT). This financial ratio, as opposed to return on sales, assesses return on investment rather than efficiency.
Return on investment (ROI), which refers to the ratio between a business’s net income and total investment, is employed to gauge the effectiveness with which an organization manages the funding provided by its shareholders. It is arrived at by dividing a company’s net income by its investment costs.
The only difference between ROI and ROS is in every metric’s chosen point of comparison for effectiveness measurement, thereby rendering them comparable yet distinct measures for measuring efficiency. ROI demonstrates how effectively a firm is operating concerning its investments, while ROS demonstrates the manner of effectiveness a business is operating to its sales revenue.
Difference between ROS and ROE
ROE or Return on equity is similar to ROI, given that both the ratios are from the point of view of investors. ROS considers revenue generated from sales whereas ROE considers equity. To be specific, equity is nothing but the difference between a company’s assets and liabilities. So once we calculate ROE we calculate the owners stake in the company.
Constraints of Return on Sales (ROS)
One of the greatest drawbacks of the Return on Sales is that it is restricted to being utilized for comparing organizations within an identical industry, and preferably among companies with comparable business strategies that correspond to comparable yearly sales.
Since businesses belonging to different industries with entirely distinct business models have very dissimilar operating margins, so comparison them using EBIT in the numerator could be puzzling. Thus, to make a comparison between diverse businesses for different industries, analysts a profitability ratio.
To make it simpler to compare the operational effectiveness of the business across different industries, analysts prefer to use earnings before interest, taxes, depreciation, and amortization (EBITDA). For example, the operating margins of a large manufacturing business and another heavy industry business are comparable in the addition of depreciation value. Return on Sales ignores non-cash items such as depreciation or amortization, which also leads to EBITDA being utilized frequently by analysts.
Conclusion
Therefore, ROS is a financial metric that evaluates how well a business produces profits from top-line sales. By examining the percentage of total revenue that is converted into operational profits, it assesses efficiency and profitability. Additionally, it enables trend analyses and internal efficiency performance by allowing organizations to compare their ROS percentage to that of competitors.
