Whether you’re a marketplace seller or run your own online store, it’s great to see lots of sales coming in. But only focusing on sales revenue can be a recipe for disaster. It’s also essential to know how much of this overall income ends up in your back pocket.
Calculating Return on Sales can help you understand how much of your revenue contributes to profits and how much of it goes towards company costs.
Let’s take a closer look at this important eCommerce metric and why you should use it.
What is Return on Sales?
Return on sales – which is also known as ROS and operating profit margin – measures how efficiently your eCommerce store is performing.
It provides an indication of how much of your revenue becomes profit and this, in turn, says a lot about your company’s level of success.
This standardized metric is frequently used across all sorts of industries. For eCommerce merchants, it is a useful tool for understanding how sales truly impact profits. It tells you how much money ends up in your pockets after the likes of stock, shipping and staffing costs are accounted for.
If you have a high Return on Sales, you keep a lot of the revenue you take in as profit. If it is low, you keep little profit and most of this income is invested in covering your business costs.
How do you calculate Return on Sales?
Return on Sales is calculated by dividing your net profit into your net sales. That might sound complicated but we’ll take you through the process in three simple steps.
Step 1: Gather the information you need
Choose the time period you want to calculate your Return on Sales for. You may want to look at a specific month, quarter or year. This metric is usually tracked continuously over time, so choose whatever frequency makes sense for your business.
Then, for the window of time you’re focusing on, you’ll need your:
- Net revenue: The value of all sales coming through every eCommerce channel
- Operating expenses: The value of outgoing costs related to your business, such as staff wages, product costs and warehouse rental
When totting up these figures, don’t include non-operating costs like tax, interest or currency exchange.
The Return on Sales metric is all about measuring your store’s performance on an ongoing basis. For this reason, you don’t want to factor in the likes of tax, which can change from year to year and is outside of your control. These costs don’t reflect your eCommerce performance.
By excluding these expenses, your real profits will be a bit lower than the metric states. But this will also give you an accurate and stable indication of performance.
Step 2: Calculate your net profit
To get your net profit, simply subtract your expenses from your net sales revenue.
Net profit = Net revenue – Operating expenses
For example, let’s say an online store specializing in pet supplies attracts $100,000 in sales from across its eCommerce platforms. It also invests $40,000 in operational expenses. Here’s how the store would calculate its net profit:
Net profit = 100,000 – 40,000
Net profit = $60,000
Step 3: Use the Return on Sales formula
Now, you can calculate your Return on Sales using the following formula:
Return on Sales = Net profit ÷ Net revenue x 100
So looking at the online pet supply store again, its Return on Sales would be:
Return on Sales = 60,000 ÷ 100,000 x 100
Return on Sales = 60%
You multiply by 100 so the metric is represented as a percentage. This makes it easier to work with. It simply shows what percentage of your income becomes profit. So a Return on Sales of 60% means 60 cents of every dollar earned is retained as profit. The other 40 cents contributes to operational costs.
Why is Return on Sales important for online sellers?
Return on Sales helps sellers measure and assess their store’s performance over months and years. It’s a simple way to maintain oversight of your business.
It’s an important metric because it can be used in so many ways. From planning to analysis, here are just some of the metric’s beneficial uses:
- For new sellers: It can help you avoid the beginner’s pitfall of achieving high revenues without making a profit
- For stores chasing stability or growth: It will let you track your progress
- For planning: It highlights long-term trends and can be useful for planning investments
- For analysis: You can see how your costs and sales are interacting so it’s also great for monitoring how a significant business investment affects profits down the line
- For funding: A healthy and stable Return on Sales can be used to gain the confidence of creditors and investors. It demonstrates your ability to repay them
What’s a good Return on Sales to aim for?
In 2019, the median Return on Sales across industries was around 7.8%. More recently, in the first quarter of 2020, the average Return on Sales of the S&P 500 – which consists of large companies on the US stock exchange – was 9.86%.
If your store outdid these figures, you’re performing better than the overall market. But what’s considered a good Return on Sales varies hugely from industry to industry.
For online sellers, it completely depends on:
- Your eCommerce niche and the products you sell
- Your store’s business model
- How long your business has been established
If your business model relies on high volume sales and small margins, a lower Return On Sales is to be expected. Often, newly launched eCommerce businesses also have a low Return on Sales as they build their name and reinvest money in their business.
While you may find the average metric for your industry here, there is usually no clear figure to aim for. You can compare your performance with that of similar stores within your industry. Alternatively, you can simply focus on marginally increasing your ROS metric each month or quarter.
How can you increase your Return on Sales?
To increase Return on Sales, eCommerce merchants can either increase their revenue or decrease their outgoing expenses.
Taking steps to do both is a good move. But you shouldn’t sacrifice any expenses which can make your business more profitable in the long run.
Some ideas for boosting revenue
- Invest in SEO for your store, as well as your Amazon and eBay listings
- Try using PPC ads, email newsletters and other eCommerce marketing techniques
- Drive conversions by asking customers for positive reviews
- Consider selling high value items to offset the cost of logistics
Some ideas for reducing expenses
- Renegotiate shipping and logistics costs
- Use technology to make your business more efficient and save money
- Use your Return on Sales metrics and other data to pinpoint unnecessary expenses
The higher your Return on Sales, the better your business is equipped to deal with a drop in conversions. So consistently working and planning to increase it will make for a healthy bottom line and a stable business. But this will take time.