Return on Sales vs. Operating Margin: An Overview
Return on sales (ROS) and the operating profit margin are often used to describe the same financial ratio. Although the two are often considered synonymous, there is a difference. The difference between ROS and operating margin lies in the numerators (top part of the equation)—the ROS uses earnings before interest and taxes (EBIT), while the operating margin uses operating income.
- Return on sales (ROS) and the operating margin are very similar profitability ratios, often used interchangeably.
- The key difference is the numerator, with ROS using earnings before interest and taxes (EBIT) and operating margin using operating income.
- Operating income is a Generally Accepted Accounting Principles (GAAP) measure, while EBIT is not.
- These two profitability ratios are used to compare companies of different capital structures in different industries.
- Higher ROS and operating margin ratios are better, meaning the company has high profitability and is efficient with generating profits from its sales.
Investors, lenders, and analysts use ROS and operating margin to compare companies of different capital structures in different industries. These metrics don't take into account the way businesses get their financing. ROS or operating margins that fluctuate a lot could suggest increased business risk. Higher ratios are better, meaning the company has high profitability and is efficient with generating profits from its sales.
Return on Sales (ROS)
Return on sales (ROS) is a metric that analyzes a company’s operational efficiency. It’s a profitability ratio. The ratio, which is earnings before interest and taxes (EBIT) divided by net sales, tells how much operating profit is produced per dollar of sales.
For example, companies in higher-margin industries, such as technology companies, will have higher ROS ratios compared to the likes of grocery chains. EBIT is similar to operating income, which is sales minus cost of goods sold (COGS) and operating expenses.
The operating margin is very similar to the ROS. The operating margin is operating income divided by sales. Operating margin, like ROS, is how much operating profit a company makes per dollar of sales.
Operating income, which is similar to EBIT, is also akin to other operational efficiency measures. Operating income is similar to operating cash flow. Operating income includes depreciation, while operating cash flow adds such non-cash measures back.
The major difference between these two ratios is EBIT versus operating income. ROS uses EBIT, which is a non-Generally Accepted Accounting Principles (GAAP) measure. The operating margin uses operating income, which is a GAAP measure.
EBIT allows for adjustments and allowances that GAAP does not allow for with operating income. Some measures of operating income are non-GAAP, such as certain non-recurring revenue and expenses items.
Notable non-recurring expenses include expenses that will not happen again, such as those incurred during mergers or acquisitions, or those incurred from the purchase of real estate or equipment. Non-recurring income can include gains on asset sales and insurance settlements. Non-recurring income can also be considered extraordinary income.