What is the Return on Sales Ratio?

How is the return on sales ratio calculation actually done? If that's the question on your mind, this article has all the answers.
For all product manufacturing companies, profits depend on the volumes of sales registered in any particular quarter or an entire financial year. The sales of a company will naturally depend on the quality of its products, competition in the market, pricing policies, decisions taken by the management, and the ability to meet the growing demand.

Importance of Return on Sales Ratio

Why should one be bothered about the return on sales ratio of manufacturing companies? The answer to this question is simple - to know about their operational efficiency. The ratio denotes how much profit a firm is making for every dollar of sales.

Good sales can help companies survive in cutthroat competition, where every firm tries to reduce its price to increase its sales. It has been observed that in such a situation, the firm having high operating profit margins or returns on sales ratio emerges to be a leader in the long term. These companies have the ability to bear the price pressure which is absent in smaller firms that are making losses on operational fronts.

This makes these companies well-placed in competitive markets. Getting high returns on sales and return on investment is not possible all of a sudden. It requires years of patience, hard work and delivering good service to the customers. A superior returns on sales ratio is possible with high level of operational efficiency which involves cutting costs wherever possible and improving cash flows, as well as total income.

Calculating Returns on Sales Ratio

Calculating this ratio is extremely easy, if you have the relevant details. Returns on sales can be calculated by taking the ratio of the net income before interest and tax, and the total sales of the company during that period. Generally, the time period for this ratio calculation is one year. It can also be calculated for every quarter of the financial year, separately. The formula presented below will make things very clear.

Returns on Sales = Net income before interest and tax/Sales

The net income before interest and taxes can be calculated by referring to the business dealing and finances of the company in that particular period. If operating margins of a company are improving, the company may experience future financial prosperity and self sufficiency. So, investors and shareholders need to consider this vital factor, before making any decision regarding investments.

Hopefully, this article will help you differentiate the profitable companies from the loss making ones. So, think smartly and take correct decisions to secure your future.