What is “return on sales” and how to improve it?
Businesses looking to increase growth may find themselves asking, “What is ‘return on sales’, why is it important and how to improve it?”. If you’re in this same position, you’re not alone.
As an important metric for business success, today we’ll answer these core questions and offer some advice on increasing return on sales in your organisation.
What is the return on sales?
Return on sales (ROS), at its core, is a measure of how efficient your operations are. It looks at your total net turnover figures and denotes how much profit is earned on every euro you take in. This is expressed as a percentage. And a higher ROS is good while a decreasing ROS is worrying. It uses your net sales and operating profit to arrive at this figure. Other names for ROS are operating income margin, operating margin, operating profit margin and EBIT margin. These terms are often used interchangeably to describe the ratio of profit or income before certain costs (such as interest and taxes) to a company’s sales. They are important in analyzing a company’s profitability and efficiency.
Who uses return on sales as a metric?
It’s not just businesses that care about return on sales. ROS is also considered when investors are looking into the viability of your business or creditors are evaluating loan applications. That’s because it’s a good indicator of the health of your company and the likelihood that you’ll be able to turn profits for your shareholders or pay back your debts. Stakeholders can use return on sales and information on outstanding or planned liabilities to get a picture of your company’s situation.
How do you calculate return on sales?
Calculating return on sales is easy. Simply put, ROS equals your operating profit divided by net sales. It looks like this:
Return on Sales (ROS) = Operating Profit / Net Sales
Now, to get those figures, you’ll need to do a few more calculations.
Calculating operating profit: In general, operating income is a figure that indicates the profit from a company’s operating activities before deducting interest and taxes. There are several ways to calculate operating income, and the exact formula may vary depending on accounting methods and business practices.
A general formula for operating income might be:
Operating profit = sales – variable operating costs – fixed operating costs
Calculating net sales: To get this figure, take your gross sales and subtract all the other costs that go into that total besides production. This could be things like discount losses, sales tax, allowances or return values.
What are the disadvantages of return on sales?
For B2B businesses, return on sales is a critical metric – just as much as it is for B2C businesses. This is because management teams need a trusted KPI for determining the overall efficiency of the business and – as we said before – it’s also important for creditors and shareholders. Tracking your trending ROS is a good idea if you want to see the trajectory of your current operations – giving you a chance to course correct if the trendline is downward.
What are the disadvantages of return on sales?
While ROS is a powerful metric, it shouldn’t be the only determinant of success. When comparing your ROS to averages within your industry, make sure you’re looking within the same market too. This will give you a more accurate picture of your standing. And, if you’re a very new business, you’ll find your costs may be higher due to the large marketing, advertising and promotional budgets needed to get a foothold. In this instance, return on investment or ROI may be a more effective short-term measurement of success.
Operating margin or return on sales 2021 averages
Across all industries in the USA for example, in 2021, the median return on sales was up from 4.8% to 9.7%; a significant growth even on the prior two year’s figures. The largest figures came from depository institutions (banks, credit unions and savings & loans) with 57.1% median ROS and from non-depository credit institutions (brokers, insurance or investment firms). Doing a like-for-like comparison with your own ROS versus your industry within your own market can help you gauge your efficiency versus competitors.
How to increase return on sales
So, knowing that ROS is important, how do you increase return on sales? Well, there are a few approaches you can try.
1. Predictive Analytics
What used to be manual adjustments to improve return on sales is now supported by predictive analytics. Predictive sales software uses advanced algorithms to analyse sales history and make predictions about your customers’ future buying behaviour. With predictive sales software, you can adjust pricing, reduce customer churn, and improve cross-selling opportunities. All of these activities have a positive impact on sales, reducing your costs and increasing your net revenue.
2. Increase product price
Now, as we said before, you can use predictive analytics to carefully adjust prices. These tools let you individually increase prices where customers are most likely to accept them. Of course, you could just do a flat percentage increase, but if you just raise prices everywhere, you could inflate churn as a result.
3. Negotiate supplier discounts
Next, anything you can do to cut your cost of goods sold will positively impact your return on sales. So, if you’re seeing a downward trend, it’s a good idea to talk to your suppliers and see if discounts are on the table. If not, and you’re outside of a contract, you could put out a tender to get more competitive quotes. Predictive analytics can show you trends in the costs of goods sold if you need justification for going to market.
4. Increase CLV
Another way to increase return on sales is to increase customer lifetime value, or CLV. There are two main ways to do this: 1. Use targeted cross-selling and up-selling activities to get your existing customers excited about other offers. 2. Lengthen the customer relationship by targeting customer retention efforts at the right time. Once again, predictive sales analytics is a powerful tool for reducing customer churn, improving customer retention, and supporting cross-selling.
5. Cut labour costs
The last suggestion to increase return on sales is to cut labour costs or boost your sales team’s results (improving productivity). Predictive sales software can help by helping your sales team focus on the most promising sales activities.
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Conclusion
o improve return on sales, we recommend strategies such as the use of predictive sales analytics, targeted price adjustments, supplier negotiations, increasing customer lifetime value (CLV), and optimising labor costs. These measures are designed to increase profitability, improve efficiency, and boost company profits.
If you’re interested in improving your return on sales, let’s have a quick, confidential conversation about your current numbers and how predictive analytics can help you today.
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