Return on Sales Ratio

For all product manufacturing companies, profits depend on the volumes of sales registered in the particular quarter or 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 ability to meet the growing demand. Knowing what a good return on sales ratio is very essential for shareholders and business partners of firms. Let us first know the importance of this ratio.

Importance of Returns on Sale Ratio

Why should one be bothered about the returns on sale ratio of manufacturing companies? The answer to this question is simple, to know about its operational efficiency and register good sales figures. The efficiency of management decisions and proper demand forecasting is what is evident from the returns on sale ratio. The returns on sales denotes how much profits the firm is making for every dollar of sales. Another name given to the returns on sales ratio in the world of accounting and finance is the operating profit margins of a company.

Returns on sales, if good, can help companies to survive in cut throat competition type of a market, 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 emerge leaders in the longer term. These companies have the ability to bear the price pressure which is absent in smaller firms, which 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. Returns on sales ratio is possible with high level of operational efficiency which involves cutting costs wherever possible and improving cash flows and 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 the interest and tax of the company, and the total sales of the company during that period. Generally, the time period for this ratio calculation is of one year. That is why, when the financial results of companies are announced, we get the annual return on sales or operating profit margins. These can also be calculated for every quarter of the financial year, separately. The formula for return on sales ratio given below will make things very clear.

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

The net income before interest and tax can be calculated by referring to the business dealing and finances of the company in that particular period. Operating margins of the company, if seeing an improvement, denotes future financial prosperity and self sufficiency. So, investors and shareholders need to consider this vital factor first before making any decision regarding investments.

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