Calculating Return on Sales
Return on Sales (ROS) indicates a company's operating profit (or loss) for a particular period—usually one year. Essentially the formula is profit divided by sale revenue, expressed as a percentage.
ROS is a useful measure of a company's operational efficiency as well as its profitability. It reflects how resourcefully each dollar of sales revenue is used, how well the company manages costs, and how it responds to difficulties like a sales downturn, increasing costs, or a fall in prices. A higher ROS indicates that a company is likely to cope well with such circumstances, and may be able to hold out against cutting its prices or entering into a price war.
ROS can be helpful in analyzing companies with seasonal or irregular income patterns, or those with a large volume of depreciating assets—perhaps as a result of substantial capital investment.
What to Do
The formula for ROS is simply:operating profit / total sales × 100 = percentage return on sales
For example, if a business makes $150 on a sale worth $950, ROS is:
150 / 950 = 0.158 × 100 = 15.8%
What You Need to Know
- Although it's a handy, straightforward measure, ROS does not reveal any information about sales costs, or contributing factors like overheads (including admin, sales and production), labor or materials.
- One version of ROS takes operating profit before deduction of interest and tax; another after deductions. It doesn't make much difference which one is used—although the former will produce a higher ratio—provided that like is compared with like.
- Operating profit may include unusual items or allowances that affect ROS, which could mislead an unwary investor.
- ROS varies greatly depending on the sector concerned. For instance, supermarkets depend on high volume sales and will consequently tend to report lower returns.
- ROS has long been a significant ratio in the retail sector, where companies use it to compare their own performance with that of competitors and the industry as a whole