Return On Sales Calculator

What this return on sales calculator does

Of every hundred that comes through the door, how much is still there once you have paid to run the business? That is return on sales, and it is the cleanest single measure of operating efficiency there is.

Give this calculator your operating profit and your revenue, and it returns the percentage.

Two inputs, one division. The whole difficulty is in the first input, because an income statement contains several numbers that all get called profit and they give very different answers. There is a section on picking the right one.

You will also see this ratio called operating margin, operating profit margin, or EBIT margin. Those are the same thing. The name changes by country and by textbook, the arithmetic does not.

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How to use it

1. Net income before interest and tax. Despite the label, this wants your operating profit, which is the same thing as EBIT. It is the line on the income statement after all operating costs and before interest and tax.
2. Sales. Revenue for the same period. Use net revenue, after returns and discounts, since that is what you actually earned.

Press Calculate. Press Reset to clear it.

Match the periods. A full year of profit against a full year of revenue, or a quarter against a quarter. Never one of each.

The tool does not currently accept a profit at or below zero, so a loss making period cannot be measured. A negative return on sales is a real and useful number, particularly for a young company, so this is on our list to open up. The arithmetic is one division in the meantime.

The formula

Return on sales = operating profit ÷ revenue × 100

A result of 9 percent means nine units of operating profit for every hundred of sales, or equivalently that ninety one units went on the cost of making and selling the thing.

What makes this the useful margin, rather than the ones above and below it on the income statement, is what it includes and excludes.

It sits after every cost of actually running the business: materials, wages, rent, marketing, depreciation, administration. So it cannot be flattered by a company that has a great gross margin and then spends it all on head office.

It sits before interest and tax. Which means it is not affected by how the business is financed or where it is domiciled. Two identical companies, one debt free and one heavily borrowed, will show the same return on sales and very different net margins. For judging the operation rather than the balance sheet, the operating figure is the one you want.

Which profit line, and why it matters

Here is one income statement with the three margins people commonly calculate from it.

Same company, same year, three defensible numbers: 40 percent, 9 percent and 5.25 percent. Somebody quoting a margin without saying which one is not telling you much.

Each answers something different. Gross margin tells you about pricing power and the cost of what you sell, and it is the right measure when comparing product profitability. Return on sales tells you whether the whole operation is efficient, overheads included. Net margin tells you what actually reached the owners after lenders and the tax authority took their share.

A word on terminology, since it causes real confusion. Some sources define return on sales using net profit rather than operating profit. Both usages exist in print. This calculator uses operating profit, which is the more common definition and the one that makes the ratio comparable across companies with different debt levels. If you are comparing your figure against a published one, check which they used.

A worked example

A business with 2,000,000 of revenue and 180,000 of operating profit.

180,000 ÷ 2,000,000 = 9.00 percent

Nine units of profit per hundred of sales. To see whether that is good, you need context, and the most useful context is your own history.

The third one looks alarming and may be entirely healthy. A 2 percent margin is normal in wholesale distribution and in grocery retail, and businesses in those sectors make their money by turning capital over many times a year rather than by making much on each sale. Which is exactly why the next two sections exist.

Margins vary more by industry than by competence

This is the single most important thing to understand before judging a return on sales figure.

A software company with a 30 percent operating margin and a supermarket with a 3 percent operating margin are not ten times apart in quality. They are in different businesses. The software company sells copies of something it built once. The supermarket buys goods, marks them up a little, and moves enormous volume.

Roughly what drives the spread. Businesses with high fixed costs and low marginal costs, meaning software, pharmaceuticals, media, tend toward high margins. Businesses that resell physical goods, meaning grocery, distribution, general retail, tend toward low ones. Capital intensive industries such as utilities and telecoms sit in between, often with decent margins and very slow capital turnover.

So comparing your margin against a company in another sector tells you almost nothing. Two comparisons that do tell you something:

Against your own past. Your margin last year, and the year before. A declining trend is meaningful regardless of the absolute level. This is the comparison most worth making and the one people skip.

Against direct competitors. Pull the accounts of two or three businesses doing the same thing you do and calculate their margins the same way. That is a real benchmark.

For published industry figures, Damodaran at NYU Stern maintains free operating and net margin data by sector, updated each January and archived for previous years. It is the best free source for this and covers several regions rather than just the US.

The thing return on sales cannot see

Margin tells you what happens on the income statement. It says nothing whatsoever about the balance sheet, and that omission is deliberate rather than a flaw.

Two businesses can both run at a 9 percent return on sales. One needs 300,000 of capital to generate its 2,000,000 of revenue. The other needs three million. The first is a far better business and return on sales cannot tell them apart.

This is why the ratio has a natural partner. Multiply return on sales by how many times a business turns its capital over in sales each year and you get return on capital employed:

ROCE = return on sales × (sales ÷ capital employed)

The supermarket at 3 percent margin turning capital over six or seven times a year comfortably out-earns the manufacturer at 12 percent margin turning it over three quarters of a time. Our ROCE calculator does that side, and reading the two together is far more informative than either alone.

Two other things worth remembering about what the number contains. It is an accounting figure, so it depends on depreciation policy, revenue recognition timing and any one off items sitting in operating costs. And it is a period figure, so a seasonal business will show very different margins across quarters without anything having changed.

What actually moves the number

Return on sales rises when profit grows faster than revenue. There are only three ways to arrange that, and they are not equally easy.

Raise prices. The most powerful lever by a distance, because a price rise flows almost entirely to the bottom line. On our example, a 2 percent price increase with no volume loss adds 40,000 of profit and lifts the margin from 9.00 to 10.78 percent. The risk is obvious and volume-dependent, which is why it is also the hardest.

Reduce the cost of what you sell. Better purchasing, less waste, cheaper inputs. This lifts gross margin and flows through, though in most businesses it is a grind of small gains rather than a step change.

Grow revenue without growing overheads proportionally. This is operating leverage, and it is the quiet one. If your fixed costs stay flat while sales rise 20 percent, margin expands without you doing anything clever. It is why growing businesses often show improving margins for several years and then stop when they need a bigger head office.

The one to be careful with is cutting operating costs indiscriminately. Marketing, research and maintenance all sit in that line, and cutting them improves this year's margin at the expense of the next few years' revenue. A margin improving while revenue stalls is worth looking at closely rather than celebrating.

Questions people ask

How do I calculate return on sales?

Divide operating profit by revenue and multiply by 100. Operating profit of 180,000 on revenue of 2,000,000 gives 9 percent.

Is return on sales the same as operating margin?

Yes, in the usual definition. It is also called operating profit margin and EBIT margin. Some sources use net profit instead, so check which one a published figure means.

What is a good return on sales?

Entirely industry dependent. Two percent is fine in grocery, thirty percent is normal in software. Compare against your own history and your direct competitors rather than against a universal number.

Which profit figure should I use?

Operating profit, before interest and tax. That keeps the ratio unaffected by how the business is financed, which makes it comparable across companies.

How is this different from net profit margin?

Net margin comes after interest and tax, so it reflects debt levels and tax position as well as operations. On our worked example the two are 9.00 and 5.25 percent for the same company.

Can it be negative?

Yes, when the business makes an operating loss, and that is meaningful information. The calculator does not currently accept it, so do the division by hand for a loss period.

My margin is falling. What should I look at first?

Split it. Check whether gross margin fell, which points at pricing or input costs, or whether gross margin held and operating costs grew, which points at overheads.

References

A note on sourcing. Return on sales is a definitional ratio rather than a standardised accounting measure, and both the operating profit and net profit versions appear in practice, which is why this page states which one it uses. Industry margin data referenced here is compiled by Aswath Damodaran at NYU Stern, updated each January and archived for prior years.

1. Damodaran, A., Operating and Net Margins by Sector, NYU Stern School of Business. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/margin.html
2. Damodaran, A., Margins and ROIC by Sector, United States, NYU Stern School of Business. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/mgnroc.html
3. Damodaran, A., Useful Data Sets, NYU Stern School of Business. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/data.html