5.1.3 Return on sales

Return on sales (ROS) indicates the percentage of sales revenue left before payment of finance costs and corporation taxes. Return on sales is calculated as follows:

Earnings before interest and tax (EBIT) is also often referred to as ‘operating profit before interest and tax’, and some companies may refer to EBIT as ‘operating income’.

This is a key ratio showing a company’s basic operating performance or core income as a percentage of revenue or, in other words, the amount of net operating profit generated by each unit of revenue. It uses the profit arising from the organisation’s productive processes. This represents the core revenue generated by the business before the impact of financing decisions (interest costs), some one-off events and taxation are considered. The rationale behind what is or is not included comes from the key purpose of this ratio: to look at the organisation’s basic or ‘underlying’ performance. ROS is often the starting point for assessing what might be expected to happen in the future.

ROS provides a first-level indication about whether the organisation has a worthwhile market position. A high figure implies that the organisation’s outputs are sufficiently attractive to its customers and they are willing to pay a price that substantially exceeds the costs of providing that product or service. If it is a high figure, this indicates that the company has a good business model and/or product portfolio. Therefore, ROS assesses the viability of an organisation’s performance and is an essentially outward-looking ‘effectiveness’ measure. It is important to note that any company can achieve high sales simply by pricing well below the cost of production. A company can undercut the competition and make dramatic sales right up until it goes bankrupt. The sign of good management – of effective management – is being able to sell at a good profit because the products are attractive to the market (and not just low priced).

The ROS measure can be thought of as a way to cast light on the organisation’s marketing capability, albeit taking the broadest definition of marketing. The product line, the distribution process, the pricing and sales strategy are all aspects of the overall ROS result, and all of these factors are encompassed by the broad definition use of the term ‘marketing’. However, ROS also inherently includes an element relating to production efficiency, particularly if ROS is very low or negative, which might be because marketing (in the broad sense) is poor, or it might be because the costs of production are much too high. In the latter case, even if the marketing is excellent, competition economics means that it will be almost impossible to have a good ROS. Allied to this point is the fact that ROS measures tend to be similar within industrial sectors. Thus, comparing ROS to average sector values can be an effective benchmarking exercise leading to important questions such as: Why do some competitors produce more or less profit from revenue?

In the case of Remote Sensors Plc ROS can be calculated as follows:

You can observe a slight decline in ROS from 2023 (21.79%) to 2024 (20.68%). One reason for this decline could be a reduced GP margin (calculated in Section 5.1.2), the impact of which is transferred here. However, management should investigate the causes of the reduction in ROS and make a conscious effort to control costs, as ROS is an index of corporate performance and can be used to compare one company to others in the same industry. Investors will often base their investment decisions on ROS. You can observe an improvement in ROS from 2024 (20.68%) to 2025 (23.07%). Again, one of the reasons for this increase could be attributable to the increased gross profit margin. For improvements in future, this analysis suggests the need for an assessment of both cost and marketing functions within the company.

Activity 4 provides you with an opportunity to practise calculating ROS and to understand the significance of changes in ROS over time.