If you want to understand how well your company is performing and make sounder decisions for the future, one of the most useful metrics you can take a look at is your return on sales (ROS). This handy metric is a measure of how successfully you have turned your sales into profits, or, how much of your total revenue can be attributed to profits versus how much was spent on operating costs. Keep reading to discover more on what return on sales is, how to calculate return on sales and what you can do to boost your return on sales for a stronger, healthier business.
What Is Return On Sales and Why Is It So Important?
Basically, return on sales is a metric that you can use to gauge the success of your business and help you determine the logic behind your sales strategies and budgeting plans. It’s also known as an operating margin, operating profit margin, operating income margin and EBIT margin.
This metric is a ratio that shows your operating income in relation to your net sales and is expressed as a percentage in most cases. It’s a great metric to really see how effective your budgeting and sales strategies have been and decide whether you need to make adjustments for better results.
Return on sales is important because it gives you a clear idea of the overall performance of your business. A solid figure means that your decisions are sound and that the company is working efficiently, particularly in sales. A good ROS is also appealing to creditors and stakeholders as it demonstrates high reinvestment potential and the ability to repay loans.
It also helps you to measure year-over-year performance as well as compare your company to other companies in the same industry and scale as you.
How to Distinguish Return On Sales From Return On Investment
Return on sales is often merged with other metrics even though it measures different aspects of a company. One of the metrics that return on sales is confused with is your return on investment (ROI).
ROI is a ratio that represents a company’s net income relative to their overall investment costs. It’s calculated by dividing the net income by the investment cost to determine how effectively the company is using shareholder funds.
It’s easy to get the two metrics mixed up as they both measure the efficiency of a business. However, ROI measures how efficient a business is against its investment costs while ROS measures how efficient a business is against its sales revenue.
Another metric that’s similar is return on equity (ROE). This metric measures the efficiency of a company against investor involvement and is calculated by dividing the net income by the shareholder’s equity.
How Do You Calculate Return On Sales?
There is a simple formula to calculate your ROS. You subtract your expenses from your revenue, then divide that figure by your revenue. Here’s an example:
If your company makes $500,000 in sales in the past quarter and $400,000 in expenses, you will first subtract $400,000 from $500,000 to get $100,000 in profit. Next, divide $100,000 by the total revenue of $500,000 to give you an ROS of 0.20. As most return on sales are calculated as a percentage, you would multiply this number by 100 to get 20%.
Using this example, you have an ROS of 20% which means that you are making 20 cents in profit for every dollar you earn.
What Is Considered A Good Return On Sales?
A good return on sales is relative to your industry and your company’s scale. A higher return on sales ratio is great as it means that your sales organisation is working efficiently and your overall business health is strong. Your sales strategies are generating considerable profit which is excellent.
You want your ROS to either hold steady or increase as your business grows bigger and makes more revenue. If it decreases while you continue to make more revenue, it means that you’re probably not pursuing as many lucrative sales opportunities as you should be.
While return on sales depends on a number of factors, a good ROS is generally considered to be between 5-10%.
How Can You Improve Your Return On Sales?
In order to boost your return on sales ratio, you’ll need to increase the gap between the amount of revenue you make and how much it costs to produce your product and run your business.
There are a few things you can do:
- You can raise your prices. This seems like a straightforward thing to do but you’ll need to complete a lot of market research and consider every aspect in order to do it successfully and prevent it from backfiring. Going too high could jeopardise your market position and alienate your customers, leaving you with less revenue and a poorer ROS.
- You can source your product materials at reduced costs. Try to negotiate with your suppliers for a discount. If this fails, look around for other suppliers that offer a better rate to lower your production costs without affecting your revenue.
- Consider stripping back how you produce your product. This can be risky as it may involve reducing staff or adjusting compensation. You have to be careful with this method and ensure it doesn’t reduce overall productivity to keep your revenue consistent.
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