Study: Efficiency Ratios: Compute and Understand the Return on Sales ratio
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Slides 1-2 (1m:17s)
Links to an external site.
Welcome to Introduction to Accounting Preparing for a User's Perspective
Compute and understand the Return on Sales ratio
The Return on Sales
Links to an external site. (ROS) ratio is a measure of a company's efficiency
Links to an external site. and is computed as follows:
Return on Sales
Links to an external site. = EBIT
Links to an external site. / Net Sales
Links to an external site.
Where:
EBIT
Links to an external site. = Net Income
Links to an external site. then add back Interest Expense
Links to an external site. and Income Tax Expense
Links to an external site.
Net Sales*
Links to an external site. = Gross Sales
Links to an external site. - Sales Returns and Allowances
Links to an external site. - Sales Discounts
Links to an external site.
* The "Sales" figure that many companies report is usually their "Net Sales" Links to an external site.figure so you will not normally see the full computation of "Net Sales" Links to an external site. on the face of their Income Statement.
ROS Links to an external site.is also referred to as Operating Margin, Operating Income Margin and Operating Profit Margin. It tries to highlight how much income a company is able to generate out of each dollar of sales after considering the related costs of operating the business.
Slide 3 (0m:41s)
Links to an external site.The ROS
Links to an external site. ratio is an indicator of a company's efficiency
Links to an external site. because by dividing the company's earnings (EBIT
Links to an external site.) by its sales (Net Sales
Links to an external site.) you obtain a ratio that indicates the amount of earnings (EBIT
Links to an external site.) the company is able to generate out of each dollar of sales (Net Sales
Links to an external site.). Therefore, if the ROS
Links to an external site. declines the company is becoming less efficient and less able to pay bills, service debt, pay dividends and increase shareholder value. If the ROS
Links to an external site. increases, it is becoming more more efficient and is more able to pay its bills, service debt, pay dividends and increase shareholder value.
Slides 4-6 (1m:36s)
Links to an external site.Users often compute a company's ROS
Links to an external site. for multiple periods of time to assess whether the company is becoming more or less efficient. Why don't we have you assess ABC company's efficiency by using its Income Statement below by:
1) computing its ROS
Links to an external site. for each year 20X1 to 20X3
2) determining whether it is becoming more or less efficient.
Please stop this video now, make your computations and perform your trend evaluation, then start the video again for further discussion .
Here are the detailed ROS Links to an external site. computations for 20X1 to 20X3 rounded to the nearest two decimals:
20X1: (Net Income $10,299 M + Interest Expense $66 M + Income Taxes $1,530 M) / Net sales revenues of $20,638 M = .58
20X2: (Net Income $12,752 M + Interest Expense $75 M + Income Taxes $1,469 M) / Net sales revenues of $23,557 M = .61
20X3: (Net Income $16,338 M + Interest Expense $89 M + Income Taxes $1,831 M) / Net sales revenues of $28,975 M = .63
In summary form, here are the ROS Links to an external site. ratios as follows:
Based on ABC's Income Statement and its ROS Links to an external site.ratios here, it appears that not only is ABC generating more Net Income, but it is also becoming more efficient because it is generating more earnings (EBIT Links to an external site.) out of each sales dollar (Net Sales Links to an external site.) increasing from only $.58 in 20X1 up to $.63 in 20X3.
Please make sure that you learn how to compute and interpret the ROS Links to an external site. ratio.
Good luck on the quiz.