What is the Return on Sales?
The return on sales is the operating income of the business expressed as a percentage of the revenue. It is a measure of the level of true income a business generates on its sales. It is calculated by dividing operating income by revenue.
Formula for Return on Sales
- Operating income is found on the income statement.
- Revenue is also found in the income statement. It may be called Sales or Turnover.
How do you calculate Return on Sales Ratio?
|Cost of sales||176,000|
In the example above the operating income is 64,000 and the revenue is 440,000. The return on sales is given by using the formula Return on Sales = Operating income / Revenue = 64,000 / 440,000 = 14.55%.
What does the Return on Sales show?
The return on sales shows how much of the revenue is left after deducting the cost of sales and operating overheads and depreciation.
The return on sales measures the ability of a business to manage its costs and overheads efficiently and to withstand adverse trading conditions.
Useful tips for using the Return on Sales
- The return on net sales will vary from industry to industry, so it is important to make comparisons to similar businesses in your sector. If your return on sales is substantially different from other businesses within your sector it will need investigation to ascertain why. A low return on sales might indicate that your selling prices are too low or your costs are too high compared to competitors. A much higher return on sales relative to competitors may indicate that you have not fully understood your costings and items have been omitted.
- The aim is to get the return on net sales as high as possible. This could be achieved by reducing the costs of the product by design or production efficiency, by reducing overheads or by increasing the selling price and sales volume, if the market will permit.
- One off items should be excluded from both revenue and operating income, as the return on sales is a measure of the operating performance of the business.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years in all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.