How to Calculate Return on Sales Ratio: Formula, Definition & Guide to Improving Your ROS
If you’re already tracking return on investment, profit margins, net sales, and other financial ratios, you might be wondering: Do I really need to track return on sales ratio, too?
I get it—not many really enjoy tracking all this financial data. But each of these metrics tells you a slightly different story about the health of your business and its profitability. And those are stories you want to hear.
So, what exactly is return on sales? How do you calculate it, and how do you use it? By the end of this article, you'll be an expert.
What Is Return on Sales Ratio?
Here’s a simple return on sales formula: ROS = operating profits divided by net revenue.
As new revenue comes in, you’re constantly spending a piece of that revenue just to keep your company going. ROS helps you see the total revenue left over after all your operating expenses are paid.
Return on sales ratio is also related to other terms, like net sales, operating income, EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), and EBIT (Earnings Before Interest and Taxes). The main goal of all these metrics is to see how much money you have at the end of the day.
Why should you keep an eye on your return on sales ratio? Kayne Stroup, Director of Finance at Close, says this: "ROS is an efficacy metric and is highly correlated to company expenditures. It's often used to compare companies in similar industries."
ROS helps you see, not just how healthy your sales system is, but how efficiently your company is running. ROS ratios don’t simply rise when more products and services are sold—instead, this ratio gains traction when your operations get more efficient.
However, it's not the end-all-be-all of metrics. As Kayne says, "ROS is a general way to track overall company efficiency. It's a fairly good high-level metric, but it will not provide you with a lot of actionable information."
So, let's talk about how to calculate it, but also how to combine it with other metrics for more actionable insights.
How to Calculate Return on Sales Ratio (Formula)
At its simplest, here’s a quick formula you can use to calculate return on sales ratio right now:
Return on sales ratio = (revenue - expenses) / total sales revenue x 100
Let’s say you’ve just closed out your second-quarter accounting books and see the following data:
- Total Sales Revenue = $300,000
- Total Expenses = $210,000
- Operating Profit = $300,000 - $210,000 = $90,000
- Return on Sales (ROS) = $90,000 / $300,000 = 0.30 or 30 percent
In this scenario, for every dollar in sales revenue you bring in, 30 percent is profit.
Of course, not everything is always that simple. Your company’s return on sales ratio can be affected by any changes in your operating costs. For example, if you’re closing a ton of sales but need to pay your team extra for commissions or overtime, your operating expenses will be higher (and your ROS ratio will be lower).
Things like paid advertising, hiring new staff, cost of goods sold, or software spending can all affect your return on sales ratio.
Why is ROS an Important Sales Metric?
At this point, you might be thinking—if I’m tracking revenue or EBIT, isn’t that basically the same?
Well, yes and no. It’s true that revenue is a key part of return on sales, but remember that this metric goes beyond just what you’re earning right now—it also helps you predict your company’s ability to continue making money into the future.
The key word here: profitability.
After all, your revenue might be fantastic. But if your operating costs are out of control, your company won’t generate enough profit to keep going.
Here are three reasons why you should be tracking return on sales ratio:
- Get a clearer picture of your financial health: For every dollar you make, how much can you actually keep? Are you covering your operating expenses, or are they getting ahead of you?
- Make better decisions about where to spend your money: For example, if your ROS is predicting trouble on the horizon, you can spend time lowering your operating expenses, like postponing that big advertising campaign.
- Get more investors: If you’re looking for investors, you can be sure they’ll check more than just your financial statements. They’ll also track your ROS, along with potential dividends and income statements. If you’re keeping up with this metric and working actively to improve it, you’ll do better at attracting the right kind of investors.
With your return on sales ratio clear in mind, you can see exactly where your company is headed and make adjustments when needed.
Return on Sales Calculation Example: Spacelys’ Sprockets
Let’s talk about how this works in the real world.
At risk of aging myself, let’s say there’s a startup called Spacely’s Sprockets. This new company hit the ground running fast. Sales have been outstanding, bringing in $500,000 in the first quarter.
But does that mean the company’s profitability has climbed too? Not necessarily.
The new sales have been much more than Mr. Spacely anticipated. He had to bring in extra staff and pay overtime to employees (like George Jetson) to meet these demands. This lowered operational efficiency and meant that the total expenses for the quarter were $460,000, leaving a net profit of only $40,000.
The Return on Sales for this quarter is $40,000 / $500,000 = 0.08 or 8 percent.
The company made a profit of just eight cents on every dollar of sales it brought in—not a very impressive return.
Will Spacely’s Sprockets survive in the long term? Only if they can get their operation costs down and improve profitability. If not, they’re likely to run themselves into the ground. (Ouch.)
How to Use Your Return on Sales Data
Knowing your return on sales ratio is one thing—how do you use that data practically?
Compare Your Company’s Performance With the Past
Your revenue might’ve gone up this quarter, but has your company’s profitability increased? Or are you spending more than you’re really earning?
For example, your revenue for Q2 might’ve increased by $50,000. That’s fantastic! But if, after calculating your ROS, you see that it’s actually gone down by 5 percent, you may need to do some serious thinking about how to cut costs without sacrificing new revenue.
Comparing how efficient your company is at earning money quarter-over-quarter can help you see red flags before they turn into major issues.
You can also use ROS to compare your company’s results with your competitors. Of course, different companies will have different return on sales, so remember to check your results only against competitors that are in the same industry and scale as you. For example, comparing a small independent hardware store to Home Depot is a poor comparison—it just isn’t relevant.
Make Better Hiring Decisions
We’ve all seen it—plenty of companies that looked solid from the outside ended up making HUGE layoffs when nobody expected it. Why? In most cases, because their operating costs were way higher than what they were actually earning.
Nobody wants this outcome. And you can avoid that by knowing how much you can realistically spend on new employee salaries. Instead of jumping into hiring a fleet of new people after a good quarter, you can use ROS to see exactly how much margin you currently have and calculate how many people you can take on board without overturning the boat.
Make Changes to Your Operations Before Things Get Dire
Let’s go back to our example above. If you’ve noticed a significant drop in your return on sales ratio quarter-over-quarter, now is the time to take action.
When you track your ROS regularly, you can see when you need to make changes. Plus, if you combine this metric with return on investment, you can also see which pieces of your overall operations can cut costs. For example, are your marketing campaigns not getting the ROI they should? Or what about that big software investment you made last quarter? Tracking these things will help you take action before things get out of control.
Let’s use our example of Spacely’s Sprockets above. Seeing he needs to turn things around, Mr. Spacely decides to:
- Hire highly qualified, highly efficient sales reps, provide training to those who could benefit, or provide job reassignment to those who aren’t fit for the role
- Identify and remove unnecessary or duplicated work processes
- Source high-quality materials at better rates for product manufacturing
The next quarter, Spacely’s total revenue from sales dropped to $400,000, but the lean workforce and operating processes cut overall operating costs to $325,000, resulting in a ROS ratio of 18.75 percent. Score!
Find Reinvestment Opportunities
As your ROS increases, the company’s profitability will increase as well. This means more of the revenue has reinvestment potential as you add new products and services and grow the company overall.
Return on Sales Ratio Compared to Other Metrics: Which Should You Use?
ROS, ROI, ROE… yes, there are a lot of financial ratios to keep in your head. Which of these metrics should you always be tracking, and how do they differ?
Return on Sales Ratio vs. Profit Margin
While these terms are sometimes used interchangeably, they’re not exactly the same. Especially if you’re dealing with investors, this slight difference will mean a lot to them.
Basically, the key is in the formula. While return on sales ratio normally counts your earnings before non-operating activities and expenses like taxes and interest, operating profit margin includes all those extra expenses in the total number.
Like I said, the difference is slight. But if you’re dealing with an industry where income taxes and interest expenses are a big deal, you may want to stick with profit margin.
Return on Sales Ratio vs. Return on Investment
Return on investment (ROI) is a completely different metric to ROS—and instead of comparing them, it’s best to use them together. While ROI measures how much money you’re getting back for every dollar you spend, ROS measures the money you get to keep for every dollar you sell.
As discussed above, you can use ROS to see when your operation costs are going up and then use ROI to see which costs aren’t getting you the return you need.
You can use this efficiency ratio to see which marketing campaigns get you a higher return, how well your sales initiatives are working, or whether or not that new software or machinery is paying off.
Return on Sales Ratio vs. Return on Equity
Again, Return on Equity has a completely different purpose than ROS. Return on Equity (ROE) reflects a company’s net income vs. its shareholders’ equity.
As opposed to tracking sales or invested dollars in specific sales and marketing initiatives, this metric demonstrates the profitability ratio for the company’s investors. Investors want to know how efficient your operation is, how good a profit margin you’re turning over, your cash flow and sales figures, and what kind of returns you generate on their investment. The basic formula for ROE is net income divided by shareholder equity, or you can calculate it using the DuPont Analysis formula:
ROE = net profit margin x asset turnover x equity multiplier
ROS, on the other hand, measur the impact of sales on overall company revenue, not just shareholder's equity.
What’s a Good Return on Sales Ratio?
Let’s not beat around the bush—obviously, the higher you get this number, the better. 🤑
But realistically, your return on sales ratio will probably be around 5-20 percent. Remember, this is just an average, and it can vary greatly depending on the market, any changes in your industry, the economic situation of your buyers, and what the competition is up to.
Kayne Stroup, Director of Finance at Close, says this: "A good return on sales ratio will vary heavily based on the industry. Some industries with thin margins would be happy with a single digit percentage, with the high end being around 30 percent."
ROS can also have a huge swing depending on your industry. For example, studies by NYU show that industries like advertising and transportation hover around 10 percent ROS, but others, like software systems and renewable energy, can see upwards of 30 percent ROS.
When calculating and tracking ROS, always remember that any positive ROS is a good start. The first time you calculate ROS, you’re establishing a benchmark or comparison ratio. Once you have that starting point, you can work to increase your ROS.
How to Increase Your Return on Sales Ratio
We’ve talked about how a 1980s cartoon character successfully increased his ROS—but how do business owners do it in real life? Good news—increasing ROS doesn’t have to be an uphill battle. Here are several ways you can improve the return on sales ratio for your company.
Regularly Review Your ROS
This metric is ever-changing, so it’s good to set a regular check-in. Build a return on sales review into your reporting schedule, either monthly or quarterly. Analyze profit trends, and look for ways to grow your business revenue sustainably.
Play With Pricing to Achieve Higher Profit Margins
Pricing is a tricky game, but when done correctly, you can increase revenue while lowering costs. Using this financial ratio, you can see which products are more profitable, and which ones are getting more sales. Then, you can prioritize selling items with higher gross profit margins.
Actively Look For Ways to Reduce Costs
It’s your job to be ultra-aware of what you’re spending on core operations and why. Review with your team regularly the cost of software, supplies, manufacturing, and other operating expenses. Then, discuss ways you can cut those costs.
For example, always keep your eyes open for discounts. Be ready to negotiate with vendors for a better price, or be open to working with new vendors who can offer you the same for lower costs.
Use Automation to Make Everyone More Productive
AI isn’t going to replace your workforce—but it can help them get their jobs done more efficiently.
As you analyze your tool stack, look for ways to build automation into your team’s everyday workflow. You might be surprised at how easy it is to automate the repetitive tasks that your team is wasting time on every day. Then, they can focus on the work that truly needs a human touch, and get more deals closed, faster.
For example, in Close CRM, your team can set up automated sequences for outreach. Plus, each touch point is automatically recorded in the CRM, meaning your team doesn’t have to waste time updating their notes every time they call a prospect.
How to Improve Return on Sales Ratio
We’ve talked about how a 1980s cartoon character successfully increased his ROS—but how do business owners do it in real life? Good news. There are several ways you can improve the return on sales ratio for your company:
- Review ROS over several months, analyze profit trends (growing or declining), and look for ways to stabilize them.
- Use ROS to determine if there are more sales on less profitable products, then prioritize the sale of items with higher gross profit margins.
- Increase prices while maintaining or lowering the cost of production and core operations.
- Reduce the cost of goods by looking for discounts, new vendors with better pricing, or less expensive supplies.
- Drive sales revenue and cash flow by pushing sales reps, marketing teams, and customer support agents to shorten the sales cycle, increase quantity, and drive upsells.
- Analyze business operations and reduce non-operating activities.
- Add ROS to the key metrics you review regularly.
Shorten Your Sales Cycle
Long sales cycles can kill a small business. If you’re waiting months for each new deal to close, work with your team to see how to shorten that cycle.
For example, sales reps can ask early what it’ll take to close the deal, and then develop parallel processes to take multiple steps at once (like sending documentation to the legal department for approval, getting a proposal sent to the finance team and other stakeholders, etc.). Sales teams can also work harder on sales strategies like closing upsells and cross-sells to increase revenue on each closed deal.
Improve Your ROS, Improve Your Business
Return on sales isn’t just about getting more profit—it’s about making your business more efficient, profitable, and future-proof.
Ready to improve your ROS? Start by getting the right tools into your stack.
With a sales-focused CRM, you can make sure your team is working at top efficiency, closing as many deals as possible with the least amount of effort. With the right CRM, you can calculate exactly how much time it takes for new deals to close, how much money you make with each new sale, and where you can improve your sales process.
Wondering which CRM is right for you? Take Close for a test run or watch our on-demand demo to see what this powerhouse CRM can do for your business.
And finally, consider using a robust CRM like Close to improve your sales team’s efficiency. We’ll help you cut operational costs while boosting sales potential.