Return on sales versus…
Return on sales is often confused with other metrics, which we will explore here. Although these metrics are quite different, when used in conjunction with the return on sales ratio, they can give you a good overall view of your company’s financial performance.
Return on sales vs. profit margin
In accounting and finance, return on sales and profit margin are often used interchangeably to describe the same financial ratio. They are both computed by taking net income and dividing it by sales. The difference between the two is that return on sales uses earnings/income before interest and taxes (EBIT) as the numerator (or top part of the equation).
Say, for example, you pay $8,000 for goods and sell them for $10,000. Your profit is $2,000 (this is your earnings/income after interest and taxes). You would then divide this figure by the total revenue to get your profit margin of 0.2. Finally, multiply this figure by 100 to get your profit margin percentage, which is 20 percent.
Do not confuse earnings before interest and taxes (EBIT) with earnings before interest, taxes, depreciation and amortization (EBITDA). While these profitability ratios are similar, EBITDA does not exclude the cost of depreciation and amortization to net profit. For this reason, many investors feel that it is not a true measure of the operating cash flow and overall financial health.
Return on sales vs. operating margin:
Although return on sales and operating margin are often used as the same financial ratio, they are different. The difference between ROS and operating margin lies in the numerator (or top part of the equation). Operating margin uses operating income while ROS uses earnings before interest and taxes (EBIT).
For example, Company A has a revenue of $150,000, its cost of goods sold was $55,000, and its operating expenses were $50,000. Its operating margin is calculated as follows:
$150,000 - ($55,000 + $50,000) = $45,000
Operating income is then divided by total revenue:
Operating Income ÷ Total Revenue = Operating Margin
$45,000 ÷ $150,000 = $0.30 (or 30%)
This means for every $1 in sales that Company A makes, it’s earning $0.30 after expenses are paid.
Return on sales vs. return on equity:
Unlike return on sales, which measures efficiency, return on equity (ROE) measures return on investment. Return on equity is calculated by using net income and dividing it by the shareholder’s equity (which is found by subtracting debt from assets of the company).
For example, if a business has average equity of $300,000 and net income (also called earnings or profit) of $100,000. The ROE is $100,000 divided by $300,000, or 0.33. So, the company made 33 cents in profit for every $1 invested.
Return on sales vs. return on investment:
As the name suggests, return on investment (ROI) is a valuation metric used to calculate an investment’s return to a shareholder. It is calculated by taking Net Income / Cost of Investment or Investment Gain / Investment Base. It can also be calculated by dividing Earnings Before Interest and Tax (EBIT) by Total Investments. Unlike return on sales, this financial ratio measures return on investment not efficiency.
Return on investment can be seen in this example:
Say an investor buys 1,000 shares of a company at $10 per share. A year later, the investor sells his shares for $12.50. Over the 1 year holding period he earns $500 in dividends. The investor also spends $125 on trading commissions to buy and sell the shares. The ROI is calculated:
ROI = ([($12.50 - $10.00) * 1000 + $500 - $125] ÷ ($10.00 * 1000)) * 100 = 28.75%
Return on sales vs. price to sales ratio
Price-sales ratio is a metric that describes how much one share of a company generates in revenue for the company. While the p/s ratio is based on sales figures (revenue) and does not take into account cash flow or profits, it is an invaluable tool when assessing the stock price and market value of relatively newer companies where income statements and other financial statements may not reflect its true value.
To figure out a company’s market capitalization, you multiply the number of outstanding shares with their current market price.
Number of shares outstanding x Company’s share price = Marketing capitalization