What does the return on sales ratio show?

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

In order not to burn out and not go bankrupt, it is necessary to keep abreast of the economic situation. You should always have an idea of the real state of affairs. If there is reliable accounting information, then mathematics will help to find out in what state the enterprise is. And if in more detail - then the profitability ratio of sales.

General information

The return on sales ratio shows the financial result of the organization's activities, focusing on how much of the revenue received is profit. It should be noted that different approaches and characteristics can be used for calculations, which creates different variations of this indicator. What is used most often? This is the return on sales in terms of net or gross profit. But the emphasis can also be placed on the operational component.

Example

There's a lot to be said about the ROI. The formula will allow you to understand it and useknowledge for your own benefit. Let's consider, taking net profit as the main value. The formula in this case is as follows: KRP \u003d PE / OP100%. The first abbreviation (KRP) stands for "sales profitability ratio". This is, in fact, the indicator we need. PE is pure profit. OP is sales volume. Here is such a simple formula. But it allows you to calculate the net profit margin on sales.

Data for calculations should be taken from the report, which summarizes profits and losses. The resulting value allows you to estimate the company's income for each earned ruble. This is potentially useful for interpreting available turnover data as well as preparing economic forecasts in a limited market that is holding back sales growth. In addition, the coefficient can be used to evaluate the effectiveness of different companies that operate within the same industry.

Change values

The formula itself will not change. If the company faces a specific task or difficult conditions, then instead of an emergency, you should substitute:

• operating profit;
• gross margin;
• earnings before taxes (and sometimes before interest).

If you know the value of the profitability ratio of sales, then to begin with, in order to have an understanding of the situation on the market, it is enough to compare its value with similar characteristics of other enterprises that are here.

AndBased on these data, we can say whether the activity is successful, what is being carried out and whether the organization has a future while maintaining this tactic. And it all allows to find out the coefficient of profitability of sales. There is no normative value for it, but if you want to navigate this issue, you can do the following: find the average value for the sector of the economy, for which you need to use state statistics. If your own result is higher, then it is good and there is potential. And if the value is lower, the situation should be changed.

How to increase your ROI?

Conditionally, there are three options here:

Increase in the amount of revenue as a percentage of costs. The reasons are the growth in sales volumes and changes in the assortment. In this case, you can pay attention to variable and fixed costs. The structure in the cost price strongly influences the profit margin. So, if you invest in fixed assets, fixed costs will increase. At the same time, there is a chance for the variables to decrease. It should be noted that this dependence is non-linear. Therefore, it is problematic to find the optimal combination. A change in the range of products offered also favorably affects the increase in revenue

• Costs are falling faster than revenues. The reasons are an increase in the cost of products, works, services, or changes in the range of sales. Formally, the profitability ratio is growing, but the volume of revenue is falling. This trend cannot becall it favorable. To draw the right conclusions, you need to analyze the pricing and the range offered.
• Revenue is up, costs are down. The reasons are price increases, changes in spending rates and/or range of sales. This is the most favorable trend. Organizations are interested in such a sustainable development direction.

Decrease

Alas, not everything is good. Often the return on sales ratio goes down. Here is a short list of options and reasons:

• price cuts;
• increase in cost rates;
• changes in the structure of the sales assortment;
• Cost inflation outpaces revenue changes.

This is an unfavorable trend. To correct the situation, you need to analyze pricing, cost control system, assortment policy. It may also be that revenue will fall faster than spending. A possible reason for this situation is a decrease in sales volumes. It should be noted that this situation is very common in cases where the company reduces its activities in the market. Then you need to conduct a thorough analysis of the company's marketing policy.

It may be that costs increase and revenue decreases. The reason for this state of affairs is lower prices, changes in the mix of sales mix and/or increased cost rates. In this case, it is necessary to conduct a pricing analysis and review the control system. This situation often arises either due to changesoperating conditions (competition, demand, inflation), or with an inefficient production accounting system.

Other formulas

One formula has already been considered earlier. Let's briefly focus on two more. The first is KRP=Gross Profit / Revenue. To convert to a percentage, you can multiply by 100%. This formula is used to show the difference between cost of sales and revenue. The second looks like this and is written as follows: EIC=Profit before taxes and interest / Revenue100%.

Conclusion

And finally, I would like to consider a few more points. The first concerns the volume of sales. It may not be immediately clear to everyone what this characteristic is. But she has a middle name that should bring clarity - revenue. In different literature, these two concepts are used in the same context, therefore, when you see such a change, you should not worry, you can continue to count according to the formulas. And the second point is the normative value. Previously, it was already casually considered, but it would be useful to supplement it.

When there are organizations with the same financial efficiency, then with a long production cycle, profitability will be higher. If the enterprise operates in a high-turnover area, then it is not necessary to count on a large value. It should be noted that profitability can show whether an enterprise is profitable or unprofitable, but it does not provide data on whether it is profitable to invest in it. Therefore, in order to get an answer tothis question you can use other indicators and formulas to help understand the situation taking place.