Return ratio

What it means

Return ratios measure how much profit a unit of invested resource produces. The denominator distinguishes return on sales, on assets and on equity - and each answers a different question.

Return on sales speaks to pricing and cost discipline, return on assets to how well the asset base is used, return on equity to what the owner earns.

Return is a ratio, not an amount of profit: a company with less profit can be more profitable than a bigger rival if it ties up fewer assets to earn it. It differs from ROI in judging the whole company over a period, whereas ROI measures the payback of one specific investment or campaign.

How it works in practice

When comparing, which profit is used matters: operating, pre-tax, post-tax or EBITDA. Changing either numerator or denominator shifts the result so much that two companies cannot be compared without the definition.

Breaking return on assets into margin and asset turnover is useful. It shows whether the company earns through a high margin on low volume or a thin margin turned quickly - two models with different risks.

In a small s. r. o. the owner’s pay distorts the ratios. If the director works without a salary or draws one well above the market, profit is artificially high or low; before comparing with competitors we put a market labour cost into the calculation, so the figures describe the company, not how the owner takes money out.

What to watch out for

A high return on equity can come from heavy borrowing rather than good operations. So it is always read alongside the structure of liabilities and equity and compared to the sector via benchmarking, not to intuition.

One-off items can redraw a single year’s return completely: selling a building, releasing a provision or writing off a large receivable. Anyone deriving a trend or a company value from such a year builds on a number that will not recur, so these items are separated out before the calculation.