Return on Sales
Return on Sales is the percentage measure used to gauge how efficiently a company transforms its sales into revenue.
Revenue or the profit margin is one of any business’s crucial and key objectives. Better profit margin and revenue or Return on sales implies the business is working smoothly and efficiently.
How to calculate Return on Sales
Return on Sales is a great parameter used to measure a firm’s success in terms of returns.
It works as a great metric to measure past or competitors’ performance with your own.
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It is usually expressed as a ratio or percentage, and a steep increase in it detects positive upliftment of the business’s health, whereas a fall implies potential financial problems.
To arrive at the Return on Sales, the following formula needs to be applied,
Return on Sales = Operating Profit divided by the Total Sales
Operating profit refers to the profits incurred by the business before the deduction of expenses like interest and taxes.
Alternatively, You can also write this formula as
Return on Sales = Revenue – Expenses divided by the Revenue
What does Return on Sales indicate?
As mentioned before, it is a parameter used to measure the performance of a business. Certain stakeholders of a business are interested in this particular metric to make decisions related to the business. These stakeholders may be internal or external.
Internal stakeholders include stakeholders, creditors, board of directors. At the same time, external stakeholders include potential investors, the government, etc.
We must calculate return on Sales annually to ensure that a clear and accurate picture is posted every year. Yearly, the expenses and incomes and areas of expenditure and streams of income change for a company as business environments are constantly changing and highly dynamic. Calculating how both of these interact with each other provides an accurate figure to people concerned with the company’s financial health.
The return on Sales for different companies varies according to the market they are involved with. A good return on Sales usually lies between 5-10%. An extremely efficient one could be higher than this bracket as well.
How to achieve a good Return on Sales?
To achieve the good financial health of your business and boost Return on Sales, businesses can take a few steps. They are as follows:
- Efficient and effective production: This means that production must be efficient, that it includes the least costs but anticipates the highest returns. Effective in this sense means processes must happen more speedily and without any wastage. In a nutshell, the best results with the most determined costs and least wastage.
- Increasing product price: this can be done by ensuring the first point and cost reduction in accumulation and processes. However, doing a lot of market research is important in this step as simply increasing product price and compromising quality is not possible. This will backfire as customers will feel they are paying overhead for a product that is not satisfactory. Ensuring good quality reputed products are acquired, and processed cost efficiently can be a great penny saver.
- Reduce selling costs: Assessing the effectiveness of sales teams or the process of production and selling is important. Assessing the market and closely watching whether competitors can sell the product at a low cost in terms of sales/marketing/assembly teams. Our business is spending a higher amount on the same can help cut these costs, thereby increasing returns.
Return on Sales thus is an extremely helpful metric to assess financial health in revenue for a business. It provides a clear picture to stakeholders and acts as a crucial factor in its profile. Understanding and closely working towards improving it to work positively is a great step towards great financial status.