Return On Sales (ROS)

Return on sales (ROS) is a ratio widely used to evaluate an entity's operating performance. It is also known as "operating profit margin" or "operating margin". ROS shows how much profit a company makes after paying variable costs of production such as wages, raw materials, etc. (but before interest and taxes). It is the return on ordinary activities and does not include one-off or non-recurring items. ROS is usually expressed as a percentage of sales (turnover).

Return on sales (operating margin) can be used both as a tool to analyze a single company's performance against its past performance, and to compare similar companies' performances against one another. The ratio varies widely by industry but is useful for comparing different companies in the same business. As with many ratios, it is best to compare a company's ROS over time to look for trends, and compare it to other companies in the industry. An increasing ROS indicates that the company is becoming more efficient, while a decreasing ratio could signal looming financial troubles. However, in some cases a low ROS can be offset by increased sales.

Formula for calculating Return on Sales (ROS)

Calculations of ROS commonly use operating profit before deducting interest and tax (EBIT) and expressing the result as a percentage:

The use of profit after tax instead of EBIT is less common.

For example, if a company has a EBIT of $100,000 and sales revenue of $1,000,000, its ROS would be calculated as follows:

ROS = $100,000 / $1,000,000 x 100 = 10%

This means that for every dollar of revenue generated, the company earns 10 cents in profit before tax and interest.

Negative ROS

A negative Return on Sales (ROS) indicates that a company's operating expenses exceed its sales revenue, resulting in a net loss for the period. In other words, the company is not generating enough revenue to cover its operating costs. A negative ROS is often a cause for concern and requires further investigation to identify the underlying issues affecting the company's profitability.

Negative ROS can be caused by various factors, such as declining sales revenue, rising costs, inefficient operations, or increased competition. For example, if a company experiences a decrease in sales revenue but fails to reduce its operating expenses accordingly, it may result in a negative ROS. Alternatively, a company may have inefficient operations that increase its operating expenses, resulting in a negative ROS even if its sales revenue remains stable.

It's important to note that a negative ROS is not always a sign of a failing company. In some cases, a company may incur temporary losses due to investments in new products, facilities, or marketing initiatives that may generate future revenue growth. However, a sustained negative ROS can indicate significant issues with the company's operations, management, or market positioning, which require immediate attention to avoid further losses.

To address a negative ROS, companies can take various measures, such as reducing costs, improving operational efficiency, increasing sales revenue, or restructuring their business model. They can also seek external funding or investment to finance their operations or explore new revenue streams. Ultimately, the key to improving ROS is to identify the root cause of the negative profitability and take decisive action to address it.

Uses of Return on Sales (ROS)

ROS is an important metric for evaluating a company's profitability because it provides insight into how effectively a company is able to generate profits from its sales. A high ROS indicates that a company is able to generate significant profits from its sales revenue, while a low ROS may indicate that the company is operating inefficiently or facing challenges in generating profits.

ROS is commonly used by investors, analysts, and management to assess the financial health of a company and compare it to industry benchmarks. It can also be used to identify areas for improvement and to evaluate the effectiveness of business strategies. A company with a higher ROS than its competitors is generally seen as more efficient and competitive.

Industry benchmark for ROS 

There is our industry benchmarking calculated using US SEC data where you can find average values for return on sales.

Advantages of Return on Sales (ROS)

• ROS is a simple and easy-to-understand metric that provides a quick snapshot of a company's profitability. It can be calculated using financial statements readily available to investors and analysts.
• ROS allows for easy comparisons between companies and industries. This makes it a useful tool for investors and analysts who are evaluating companies across multiple industries.
• ROS can be used to identify areas of a business that are performing well and those that may need improvement. By analyzing the factors that contribute to a company's ROS, management can identify opportunities to increase profitability and reduce costs.

Limitations of Return on Sales (ROS)

• ROS does not take into account the size of a company's sales revenue. A company with high sales revenue may have a higher net profit, but a lower ROS than a smaller company with lower sales revenue.
• ROS may be influenced by accounting practices, such as the timing of revenue recognition or the treatment of expenses. This can make it difficult to compare ROS between companies that use different accounting methods.
• ROS does not provide insight into the level of risk involved in generating profits. A company with a high ROS may be taking on significant risks that could affect its long-term profitability.

Formula in ReadyRatios Analysis Software

ROS = EBIT / F2[Revenue]

where: 
F2 – Statement of comprehensive income (IFRS).
EBIT – earnings before interest and taxes. EBIT is calculated by subtracting a company's operating expenses from its revenue, excluding any interest expenses or taxes.

Conclusion

Return on sales (ROS) is an important financial metric that measures a company's profitability by evaluating the amount of profit generated for every dollar of sales revenue. ROS is a useful tool for investors, analysts, and management to evaluate a company's financial health, compare it to industry benchmarks, and identify areas for improvement. However, ROS does have some limitations and should be used in conjunction with other financial metrics and qualitative analysis to provide a comprehensive view of a company's financial performance.