Perhaps you’d like to find an investor for your business or gauge your success against your competitors. Or maybe you just want to know how profitable your business is this quarter compared to last quarter. Regardless of the reason, knowing how to calculate the return on sales ratio is vital.
Knowing how to find your return on sales gives stakeholders a snapshot of your business’s financial well-being and insight into its potential for growth and success. Understanding the importance of this figure and the formula you should follow to establish it could be your key to business growth.
This post delves into the finer details of return on sales, including what it is, why it’s essential, and strategies you can employ to increase yours. We’ll also break down the return on sale formula and walk you through a return on sales calculation example.
Return on sales (ROS) is an integral measurement to help you determine whether and to what extent your business is profitable over a given period. It shows you what percentage of your overall sales revenue is profit and the amount allocated to operating expenses.
Businesses calculate their ROS regularly to evaluate their performance in relation to competitors and the market. The result of the return on sales calculation lets them know whether their sales and financial strategies make sense and whether any changes need to be made.
When tracking your return on sales, you should notice an increase as your business grows—A higher return on sales ratio indicates greater profitability. If not, it’s perhaps wise to analyze your expenses, pricing, and revenue-generating model.
The importance of return on sales
Calculating your ROS is vital to determining the overall financial health of your business. In fact, it’s one of the quickest ways to determine whether your company is performing as well as you expect it to. Here are some of the more specific benefits associated with calculating and monitoring your ROS:
Identify business growth: Using the return on sales formula, you can track profit fluctuations and determine whether your business is growing or stagnating.
Determine financial feasibility: Investors, creditors, and other stakeholders may want to see your return on sales metrics to predict your business’s viability for reinvestment, loan repayment, or dividend payment.
Establish accurate profitability: Just because a company’s revenue is high doesn’t mean it’s profitable. Calculating your ROS gives stakeholders a more realistic overview to determine your business’s profitability.
Run a competitor analysis: While return on sales varies by industry, competitor ROS figures present an ideal benchmark for your business’s profitability compared to similar companies.
Improve your operation: Monitoring your ROS will help you identify strategies for improvement, such as reducing labor costs, minimizing materials expenses, increasing team efficiency, and improving sales revenue.
How to calculate your return on sales
Calculating your return on sales is simpler than it may seem, but it will require good accounting software and a robust CRM system to capture the data you need.
With the right software and CRM integrations in place, you can create a custom report to determine your return on sales. After that, drawing a return on sales report can be as simple as clicking a button.
If you want to calculate your ROS ratio manually, you’ll need to know the formula.
ROS Formula
There are actually two parts to the ROS formula. First, you’ll need to calculate your operating profit, which you’ll do using the following formula:
Once you have your operating profit figure, you can use the following ROS formula to determine your company’s return on sales:
Step 2: (Operating Profit ÷ Net Sales Revenue) x 100 = Return on Sales
Bear in mind that the operating expenses used in this formula should not include your company’s taxes and interest expenses.
Return on sales calculation example
Let’s walk through a return on sales calculation example to illustrate how this formula would work in a real-life situation.
If a business generated $750,000 in net sales revenue over the last quarter but also spent $600,000 in operating expenses over that period. The business’s ROS calculation would look like this:
Step 2: (Operating Profit ÷ Sales Revenue) x 100 = Return on Sales
($150,000 ÷ $750,000) x100 = 20%
In this calculation, the resultant ROS is 20%, which would be considered relatively high in the real world, depending on the type of industry and company size. Generally speaking, a ratio of between 5% and 10% is considered a respectable return on sales.
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Several macro- and microeconomic factors influence your ROS and whether it’s considered good or bad. Some you can change and manage, while others are beyond your control. These are the primary factors you should be aware of.
Industry standards
Optimal ROS benchmarks differ depending on your industry, market, sector, and specialization. Knowing the standard for businesses like yours will help gauge whether your ROS meets the bar and whether your sales and business processes are working.
Operating costs
What you spend to support your operation depends on your business type—Some businesses have higher operating costs than others. But the higher your operating expenses, the lower your ROS will be. So, assessing and monitoring these expenses is essential to ensure you aren’t spending unnecessarily.
Gross profit margin
While your operating expenses will affect your gross profit margin, it’s not the only determinant. How you price your products and services will also significantly influence this number. Of course, the higher your gross profit margin, the higher your ROS. Therefore, ensuring a competitive and sensible pricing strategy can make all the difference to your return on sales ratio.
Sales revenue
It stands to reason that the more money your sales team generates, the more profit you’ll enjoy. As your company grows and your sales revenue and profit increase, there’s a chance that your return on sales percentage will increase, too. However, an increase in sales may also mean an increase in operating costs, which could even things out, leaving you with little to no increase in ROS.
Business growth
As your business increases its customer base and revenue over time, it may undergo changes that influence profit margins and your return on sales figures. For example, business expansion may result in you bringing previously outsourced processes into your internal operations, potentially reducing operating costs. With an increase in revenue and a reduction in operating expenses, you’re sure to see improvements in your ROS as your business grows.
Competitor trends
Your direct competitors determine the nature of the market you operate in, and how they operate affects your competitiveness within that market. For instance, in a highly competitive market, you may be forced to follow a specific pricing structure to remain relevant and ensure a good profit margin.
This way, competitor trends and behavior can significantly affect your business’s ROS. Understanding your market and competitors could provide insights that help you develop strategies to differentiate yourself and improve your ROS.
Strategies to increase your return on sales
Increasing your return on sales is possible and, of course, related to the factors influencing it mentioned above. In essence, you’ll want to improve your income-to-spend ratio, where your income increases and your operational costs decrease. This raises your profit margin, thus increasing your ROS.
But how do you increase the gap between your sales revenue and operational expenses? Here are a few ways you can achieve this.
Increase your pricing
This may sound obvious and somewhat straightforward, but increasing your pricing structure is easier said than done. To do so strategically, you’ll need to do some serious research to ensure you don’t price yourself out of the market.
Given the nature of your business, industry, and competitors’ pricing, consider whether a price increase makes sense for you. If not, perhaps there’s a way you can add more value to your offering at a slightly higher premium to increase revenue. This could involve adding new products, services, or packages or simply adjusting your existing pricing.
If you decide to alter your pricing structure, it’s always best to survey your customers and explain the benefit to them should your prices increase. Testing the market with a separate offering at a higher price may also be worthwhile to see how your target market responds.
Reduce your operating costs
Cutting down on operating expenses is a great way to increase your profit margin and improve your ROS ratio. However, unlike increasing your pricing, reducing what you spend on materials, components, and products is not entirely in your control.
To minimize expenses, you’ll need to approach your suppliers and engage in discussions related to cost reduction. Some of the options you could bring to the table include:
Asking for a discount
Negotiating a better price
Inquiring about cost-effective alternatives
While dealing with suppliers you’ve built a relationship with is ideal, you may be forced to shop around for alternative vendors. Bear in mind, though, that it’s not just about the product and price. Service is just as important a factor to consider—Your supplier’s service level could directly affect your service delivery and customer satisfaction.
So, if you decide to try out other suppliers with more affordable materials, put them to the test before closing any existing vendor accounts.
Change your production or sales process
One way to do this is to reduce the number of employees assigned to these processes, which could mean letting staff go. While this isn’t an ideal approach, it can effectively increase your ROS, provided that losing employees does not compromise product or service quality and delivery.
One way to alter your production process is to change the materials and methods used to produce or sell. For example, perhaps a tweak in product design could reduce costs over the long run while still providing customers with the solution they seek. To streamline your sales process, you could cut back sales and marketing expenses to focus only on channels that consistently bring an above-average ROI.
The production or sales process changes available to you will depend on your specific business operation. But evaluating where you’re spending your money and what you can change to reduce costs could be a beneficial exercise.
Improve your ROS with an efficient sales process
An efficient and productive sales team could be the difference between a good or bad return on sales ratio. Sales efficiency and productivity invariably translate to reduced operating costs and increased sales revenue—hence, an increase in your ROS.
That’s why an effective sales process is imperative. With a great process in place, your sales reps have a proven roadmap to guide prospects and leads through your sales pipelines and win more deals. And the best way to provide your team with an ace sales process is through a reliable and technologically advanced CRM system.
Nutshell provides sales teams with all the tools needed to manage, nurture, and interact with leads and customers, driving more sales revenue. With Nutshell, you can look forward to:
Sales automation tools that allow you to automate tasks, activities, and reminders, saving your team a great deal of time
Email synchronization that brings all your email communication, contacts, and calendar events into one central system
Pipeline management that makes viewing and sharing lead information easier and gives your team what they need to close more deals
Reporting and analytics capabilities to ensure you’re always on top of your business’s most important metrics, including your return on sales percentage
Email marketing feature access to get your message out to your prospects and customers timeously and professionally
Thousands of integrations to connect all the software in your business’s tech stack with your CRM system as its foundation
Want to give Nutshell a try? Simply sign up for our 14-day trial to experience everything our powerful CRM has to offer—no credit card required. You’re also welcome to contact our team to discuss how Nutshell can benefit your business and meet its unique needs.
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