What Is After-Tax Return on Sales?
After-tax return on sales is a profitability measure that indicates how well a company uses its sales revenue. A high after-tax return on sales signals that the business is well run, while a low reading communicates a lack of efficiency and could serve as a red flag for impending financial distress.
- After-tax return on sales is a profitability measure that indicates how well a company uses its sales revenue.
- It is calculated by dividing the company's after-tax net income by its total sales revenue.
- Companies that display higher levels of after-tax return on sales tend to pay less tax and be in sectors with higher profit margins.
- Profit-margin standards can vary widely by industry, so this ratio should only really be used to compare different companies within the same sector.
Understanding After-Tax Return on Sales
Companies are quick to talk up how much money they are making, though in reality what should really concern investors is how much they are left with after deducting all expenses. Generating billions in revenues is nothing to shout about if it becomes apparent that the cost to earn that income is more or less the same.
Keeping possession of a decent chunk of total sales signifies that the business model is strong and reassures investors that there's enough left in the bank to maintain and improve assets, fend off competitive threats, pursue acquisitions, and return money to shareholders. After-tax return on sales is one of the metrics used by investors to determine how much of their revenues companies keep hold of after all the bills have been paid.
Calculating After-Tax Return on Sales
After-tax return on sales is calculated by dividing the company's after-tax net income, the amount of money that's left over after accounting for all expenses, including taxes, operating expenses, interest, and preferred stock dividends, by its total sales revenue. The resulting figure, multiplied by 100, will be a percentage; the higher the percentage, the more efficiently the company uses its sales revenue.
Companies that display higher levels of after-tax return on sales tend to pay less tax and be in industries with higher profit margins. Profit margin is the share of every dollar of a company's revenue that gets booked as a profit, instead of spent as an expense. For instance, if during the last quarter a company registers a 20% profit margin, it means that it had a net income (NI) of 20 cents for each dollar of sales generated.
Profit margins hinge on several factors, including how much it costs a business to generate sales, demand for the product or service being produced, and competitive pressures in the marketplace. Industries with less competition tend to have wider profit margins, because there are fewer companies fighting over the same level of customer demand. With greater levels of competition, pressure to lower prices rises, weighing on profitability.
Taxation is also an important factor here. In jurisdictions with higher taxes, after-tax return on sales will be lower, because the metric takes into account how much a company must pay the government in taxes. At present, forty-four states levy a corporate income tax, with rates ranging from 2.5% in North Carolina to 12% in Iowa.
Examples of After-Tax Return on Sales
Within the S&P 500, pharmaceutical and biotechnology companies tend to register a higher after-tax return on sales, followed by energy and exploration firms and software and software-related services. In the United States, consumer staples, which sell essential products like those provided by supermarkets, usually have the lowest after-tax returns on sales.
Advantages and Disadvantages of After-Tax Return on Sales
After-tax return on sales comes in particularly handy for investors keen to compare different companies within the same industry. Beyond that, this profitability ratio generally serves little use.
Each sector has different cost structures and competition levels, meaning that profit-margin standards can vary widely depending on the type of company you are examining. In other words, it would not make sense to compare the after-tax return on sales of an automobile manufacturer to that of a clothing store.
It's also worth pointing out that a single profitability ratio only provides a small piece of the overall picture of a company's financial performance. To get a more accurate and complete idea, investors are advised to expand their research. Using various ratios focused on different financial data helps to build a more complete analysis of a company's health and expose flaws that some metrics may fail to account for.