Just producing products is not enough to make a profit. Obviously, it needs to be sold. The process of selling (selling) may be almost more difficult than manufacturing, but its importance can hardly be overestimated. Obviously, the effectiveness of the implementation process requires close attention. Like many other aspects of the functioning of an enterprise, sales activities can be measured using a profitability indicator. In this case, it makes sense an indicator called return on sales.
This ratio shows what proportion of the revenue is profit. If there is information, the indicator can be calculated both for the enterprise as a whole and for individual products. The overall return on sales is, based on the foregoing, the ratio of profit to the amount of revenue received. The revenue indicator is always determined in the same way, with it there are practically no problems. But with the profit indicator, the situation is much more complicated, since it can be determined by a huge number of ways, taking into account some factors and not taking into account others. Let us dwell on this point in more detail.
Many profitability indicators are calculated based on net profit. In this case, you can go the same way and use this particular value. The thus calculated return on sales shows the share of profit taking into account the influence of the largest number of factors. These include pricing policy, cost management policy, tax features, borrowed capital fees and some others. The problem with this calculation is that net profit depends on factors that are not related to the production and sale of products, that is, from other income and expenses. In addition, accounting for taxes and fees for borrowed capital does not allow comparing the calculated indicator with the levels of other firms if they are taxed differently or have a different capital structure.
The foregoing can be taken into account by using profit before tax or an indicator of profit from sales. When calculating on the basis of profit before tax, return on sales shows the efficiency of production and sales under the influence of all factors except taxation and allows you to compare organizations with different tax status. However, in this case, profit still experiences the influence of other activities of the company, which somewhat distorts the information about the main production. With significant indicators for other activities, it is advisable to calculate profit from sales. Excluding taxation and other activities, sales profitability shows the effectiveness of activities only taking into account pricing and cost policies. Using the coefficient calculated in this way, it is easiest to compare various enterprises among themselves, since only the most significant factors are taken into account.
As you can already understand, one of the most commonly used methods of analysis is to compare the performance of one enterprise with the same ratios defined for other firms. In addition to such comparisons, comparisons with industry average values can also be used. However, horizontal analysis is most often used , which consists in comparing indicators of one enterprise for several periods among themselves. Changes in indicators are determined and trends are identified that allow us to judge the effectiveness of certain managerial decisions made.
It is worth noting that almost all profitability indicators are closely interrelated and affect each other. Thus, return on sales has a particularly strong impact on the efficiency of use (profitability) of equity and assets. To assess the level of this influence, you can use a special type of study called factor analysis.