Return on sales

What it means

Return on sales expresses profit as a percentage of sales and shows how many cents of profit a company earns on each euro sold. It is one of the basic return ratios and performance indicators, easily calculated from the profit and loss statement.

It can be based on net profit, EBIT or EBITDA, and the results differ considerably. Return based on net profit includes the effect of interest and tax, while the EBITDA margin shows operating performance before depreciation. Comparisons require knowing which profit was used.

Unlike ROE and ROA, which measure profit against invested capital or assets, return on sales measures the efficiency of selling itself. A low-margin company can have a high ROE if it turns its assets over quickly, and vice versa.

How it works in practice

Return on sales is tracked over time and against similar companies. A decline may signal price pressure, rising costs or a shift in the sales mix towards less profitable products. Analysis by product or customer shows where margin is being lost.

Typical values vary widely by sector. Grocery retail operates on low single-digit percentages, while software or consulting can reach tens of per cent. Comparison with sector averages from published statements is therefore more meaningful than general benchmarks.

The ratio helps with pricing and planning. A company that knows what return it needs to fund investment and reward its owners can work back to the prices and cost limits required at a given level of sales.

What to watch out for

One-off items such as asset sales or exceptional write-downs distort a given year's return. When assessing the trend, it is better to use adjusted profit and a multi-year average.

A high return on sales alone does not guarantee a healthy company. If profit is tied up in receivables and inventory, cash may run short. Returns must be judged together with cash flows and turnover ratios.