As an entrepreneur, you have to familiarize yourself with a handful of different metrics. They’re super useful when it comes to optimizing your business processes and planning future growth. If you are familiar with certain indexes, ratios and percentages, you can adopt strategies, create plans and gather useful data on handling day-to-day operations in the best way. In this article, we’ll focus on one of those metrics – ROS or Return on sales. Let’s look at why it is important, why you should measure it, how you should measure it and much more. Let’s get to it!
First up – what exactly is Return on sales (ROS)?
It’s one of the more vital metrics that can indicate how well your e-commerce shop or any other business is doing. The ROS metric reflects on the whole range of operations, so it’s used to describe and monitor the health of the whole company rather than just a single project, department, etc. However, that doesn’t mean that every single employee and/or process impacts ROS. It’s only linked to the sales, pricing plans and cost management areas of your business. To help you better understand – here’s how you calculate Return on Sales!
Return on Sales (ROS) Formula
(Revenue - Expenses) / Revenue = Return on Sales
So, as we can see, this ratio indicates the relation between revenue and costs. Thus, it compares the two most important metrics and we get a ratio from the two. This ratio is probably the clearest way to see how efficiently your business is working.
The higher the ROS – the better your business is off, to put it plainly.
What’s a good Return on Sales ratio (ROS)?
In order to understand what separates good from bad, we have to also keep in mind that every niche is different. For example, retailers like Walmart, Amazon or Target work on very fine (small) margins, meaning that their return on sales is very low. But, since they have huge volumes and very optimized cost management, the overall profit and revenue figures are high. This helps sustain their business and shows a decent ROS ratio.
But if you were to look at, let’s say manufacturers of custom furniture – their margins and initial costs are much higher. But they don’t sell as much, meaning that in order to remain profitable and financially stable, they need to have a very high Return on Sales.
There is no individual figure which can be deemed as a “Good ROS”, but anywhere around 10% is satisfactory for medium to large businesses. Exceptions apply to extremely large companies like the aforementioned Walmart, Amazon, etc. who work on 2-3% margins meaning that they have a 0.02-0.03 ROS ratio.
Whereas the chart below shows the Return on sales in the soft drink industry.
Source: Company statements
As we can see, the average ROS is somewhere around 15-25%, which means that if you want to compete in this market, you have to measure your business and look for a 0.2 Return on Sales as a good result. Of course, there are different niches and ideas that you can promote and fit yourself in the category of Monster Energy and similar companies (focus on higher margins but don’t attack with as much volume). All in all, the term good return on sales ratio is very relative and you should analyze your competition to know more about what you’re aiming for!
How to utilize these calculations for the benefit of your business?
Constant measurement helps monitor the financial health
Now that we know how to estimate and how to figure out whether the ratio is good or not, it’s high time we looked at what benefits does the calculation of this metric bring.
To start, you have to constantly track this figure. Most western companies do it on a quarterly basis which helps them monitor the financial health of the company and efficiency of marketing campaigns, growth plans, other strategies, etc. In an ideal world – ROS should grow every quarter. If you’re able to sustain stable and constant growth, you’re doing a good job. If the Return on Sales is stagnant and doesn’t rise nor fall, it might mean that your business is in need of a new marketing campaign or that your product and/or service is at the end of its life cycle and reached its ceiling. The solution would be to re-evaluate marketing plans, introduce new products or restructure the entire company’s approach to sales.
And finally, if you see your Return on Sales figures diminishing, that’s a very big red flag. If you’re moving backwards, it means that the current business model isn’t sustainable long-term. A lot of swift changes must be implemented in order to save your activities.
It helps locate weak spots and improve efficiency
Since you can easily monitor and track the ROS metric, you can continuously keep track of how various innovations and changes impact your sales. This ratio isn’t just a rough overview of your business’s profitability. It’s also a great way to see whether you’re doing things efficiently and optimizing processes. By going more in-depth into your operating costs tab and doing A/B testing, you can find out which departments of your organization aren’t working as efficiently as others and which ones are doing just fine.
So, as an example, let’s say that you increase the funding for advertising but don’t see an increase in the ROS. Maybe the ad campaign was poorly designed or maybe you targeted the wrong audiences? The revision of the marketing campaign is in order. The same applies to other areas where you can find weaknesses to fix up!
So, as we’ve covered – Return on Sales or ROS is a very important metric that helps monitor the overall efficiency of your business operations. By continuously tracking this ratio and measuring it against your competition, you can better optimize various processes and step ahead of the competition by outsmarting them right now and long-term!