The return on sales is the operating income of the business expressed as a percentage of the revenue. Consequently it is a measure of the level of true income a business generates on its sales. In order to calculate the ratio we divide the operating income by the revenue.
Return on Sales Formula
In the formula above both operating income and revenue are items on the income statement of the business. Alternative names for revenue include sales and turnover.
Return on Sales Ratio Calculation
| Revenue | 440,000 |
| Cost of sales | 176,000 |
| Gross profit | 264,000 |
| Overheads | 200,000 |
| Operating income | 64,000 |
| Interest | 20,000 |
| Tax | 9,000 |
| Net income | 35,000 |
As can be seen in the example above the operating income is 64,000 and the revenue is 440,000.
Accordingly the calculation of the return ratio is as follows.
Return on Sales = Operating income / Revenue Return on Sales = 64,000 / 440,000 = 14.55%
What does the Return on Sales show?
The sales ratio shows how much of the revenue is left after deducting the cost of sales and operating overheads and depreciation.
Consequently the ratio 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 Sale Formula
- The ratio 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 sales ratio may indicate that your selling prices are too low or your costs are too high compared to competitors.
- A much higher ratio 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 ratio 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 ratiois a measure of the operating performance of the business.