Return on sales is one of the most important metrics your organization can track to gauge the health of your business and test the logic behind your budgeting and sales strategies. The figure is reported as a ratio and shows how much of your overall revenue results in profit versus paying down operating costs.
Keeping tabs on your ROS is central to understanding how your company is performing and making sound decisions for your business — so here, we'll explore the concept of return on sales a bit further, review how to calculate it, touch on why it's important, go over what a good one looks like, and see some strategies you can leverage to improve yours.
What is return on sales?
Return on sales (ROS) — also known as operating margin, EBIT margin, operating profit margin, and operating income margin — is a ratio that considers your operating income relative to your net sales. The figure is typically expressed as a percentage.
Ultimately, return on sales is a metric that shows how much of your sales revenue is translating to profit, relative to operating costs — making it one of the better metrics for gauging the efficiency and effectiveness of your budgeting and sales strategies.
Return on sales is often conflated with similar metrics — including return on investment and return on equity. Let's take a look at the key factors that set ROS apart from those other figures.
Return on Sales vs. Return on Investment
Return on investment (ROS) represents the ratio between a company's net income and overall investment — it's ultimately used to gauge how effectively a company is using the funds shareholders are providing. It's calculated by dividing a business's net income by the cost of investment.
ROI and ROS are similar in that they're both used to measure efficiency — the distinction between the metrics is in each one's respective reference point for that measurement. ROI shows how efficiently a business is performing with respect to its investments, whereas ROS represents how efficiently a business is performing with respect to its sales revenue.
Return on Sales vs. Return on Equity
Return on equity (ROE) is similar to ROI in that it measures efficiency as it stems from investor involvement. It's calculated by dividing net income by shareholders' equity. Like return on investment, return on equity differs from return on sales when it comes to the reference point it uses to gauge performance — ROE considers equity whereas ROS considers sales revenue.
How to Calculate Return on Sales
Return on sales is calculated by dividing your business’s operating profit by your net revenue from sales.
Return on Sales Example
Let’s say your business had $500,000 in sales and $400,000 in expenses this past quarter.
If you wanted to calculate your return on sales, you would first determine your profit by subtracting your expense figure from your revenue. In this example, you’d have $100,000 in profit. You would then divide that profit figure by your total revenue of $500,000 — giving you a ROS of .20.
ROS is typically reported as a percentage, so in most cases, you would be expected to multiply that final number by 100 and use that to report your ROS — in this case, it would be 20%.
That percentage represents how many cents you make in profit for every dollar you earn in sales. Here, your ROS would be 20 cents per dollar.
Return on Sales Formula
To calculate return on sales, subtract your expenses from your revenue and divide that figure by your revenue. Return on Sales = (Revenue - Expenses) / Revenue
Why Is Return on Sales Important?
Return on sales is one of the most straightforward figures for determining a company’s overall performance — specifically when it comes to the health and effectiveness of your sales org.
A solid return on sales indicates that your company is likely operating efficiently, making sound decisions, and pursuing viable sales opportunities. Stakeholders and creditors are often interested in the metric because it provides an accurate overview of a company’s reinvestment potential, ability to pay back loans, and potential dividends.
ROS is also one of the more reliable figures for measuring year-over-year performance. A company’s revenue and expenses could vary over time, so higher revenue might not be the most accurate metric of a company’s profitability.
If you're generating $1,000,000 in revenue with an ROS of 2% after generating $250,000 in revenue with an ROS of 8%, it might mean you're sacrificing efficiency as you scale — and you need to reevaluate your sales strategies, broader internal operations, target personas, or any other factors that might be weighing you down.
It can also be used to compare your company's performance, relative to other companies. That being said, return on sales can vary significantly from industry to industry and scale to scale. So if you're using ROS to compare your business with another, it only makes sense if that business is your space.
What is a good return on sales?
A solid ROS means you're generating considerable profit from your sales efforts — so obviously, a higher return on sales ratio reflects better on both your sales organization's and broader business's effectiveness, efficiency, and overall health.
A good return on sales ratio either increases or holds steady as your business generates more revenue. If you initially had an ROS of 10% while generating $100,000 in revenue but a ROS of 5% when you increase your revenue to $1,000,000, it would mean your sales org is operating less efficiently — that you're likely pursuing fewer lucrative or viable sales opportunities than you should be.
And as I touched on in the previous section, the concept of a "good return on sales" is relative — the figure hinges on factors like your company's scale and industry. That said, as a general rule of thumb, a good return on sales tends to hover around 5-10%.
How to Increase Return on Sales
The only way to increase return on sales is to put a bigger gap between your revenue and the cost it takes to produce your product. There are a few ways to accomplish that.
Increase the price of your product.
This might be the most straightforward way to increase return on sales — it's at least the one you have the most control over. But "straightforward" doesn't mean "easy" in this context. It takes a lot of careful consideration and market research to carry out effectively.
Going this road could just as easily backfire on you. If you raise your price too radically and undermine your market position or alienate your base, you'll wind up with less revenue — and a worse return on sales figure than you started with.
Pursue discounts and cost reductions for your product inventory or materials.
This method plays on the other element of return on sales — your expenses. If you're reluctant to raise your price, you might want to explore this possibility. Reach out to your suppliers, and see if you can negotiate better rates for your product inventory or materials.
If they won't budge, try looking into other vendors to see if they're willing to offer lower prices. One way or another, actively and aggressively pursue discounts that will have a meaningful impact on your production costs without adversely impacting your revenue stream — again, something much easier said than done.
Strip back how you produce or sell your product.
This is another method businesses can use to reduce costs and, in turn, improve return on sales — but it's a particularly risky, difficult, and sometimes ethically dubious road to take. Stripping back how you produce or sell your product might mean adjusting compensation or letting some employees go.
You also have to be extremely careful and make sure that shifting how you pay your employees or changing what's expected from them doesn't adversely impact overall productivity. You need to keep your revenue at least somewhat consistent if this method is going to work.
Return on Sales vs. Profit Margin
The terms "return on sales" and "profit margin" are often used interchangeably, but those semantics are only partially accurate. There are different kinds of profit margins — only one of which is the same as return on sales.
Net profit margin
Net profit margin (sometimes referred to as rate of return on net sales) is a ratio that compares net profits and sales. You can calculate this figure by dividing a company’s net profit after taxes and total net value of sales. If your company had profits of $150,000 after taxes and net sales of $100,000, you would have a net profit margin of 1.5 or 150%.
Net profit margin is a metric that helps companies compare how they have performed over different time periods. Companies typically use this figure when looking over past performance.
Gross profit margin
You can calculate a business’s gross profit margin by subtracting the cost of all goods sold from the value of the sales and then dividing that figure by the value of sales. If you had sales of $50,000 and the cost of goods sold was $20,000, you would subtract $20,000 from $50,000 and divide the difference of $30,000 by the sales value of $50,000 — giving you a gross profit margin of .6 or 60%.
Gross profit margin is generally used as a benchmark for comparing different companies. It’s a good way to gauge how efficiently a specific company can generate profits relative to its competitors.
Operating profit margin
Operating profit margin is another term for return on sales. Use the ROS equation to find this figure.
Return on Sales Ratio Calculator
If you're interested in a return on sales ratio calculator to make finding yours a little easier, here's one from Omni Calculator.
Return on sales is an important metric with a variety of applications. As a business owner, you must have a picture of yours. If you want to know how efficiently you’re turning over profit, you should understand what ROS is and how to calculate it yourself.