What Is Return on Revenue?

What Is Return on Revenue?

Let me explain return on revenue (ROR) to you directly—it's a straightforward measure of a company's profitability based on the revenue it generates. Essentially, ROR compares the net income produced for every dollar of revenue, giving you a clear picture of efficiency.

Why ROR Matters

You should know that ROR is one of the most critical financial metrics for evaluating a company's profitability. It helps you determine how effectively the management team is generating sales and keeping expenses in check. Keep in mind, ROR is also referred to as net profit margin.

Understanding Return on Revenue (ROR)

ROR represents the percentage of profit derived from revenue. Revenue is the money a company earns from selling goods and services, and it's listed at the top of the income statement— that's where you subtract all expenses to reach net income. In retail, you might see it as net sales or net revenue, adjusted for discounts and returns.

Net income is the profit left after subtracting costs like production expenses, taxes, operating costs, and overhead such as selling, general, and administrative expenses (SG&A). You'll find net income at the bottom of the income statement, often called the bottom line.

What ROR shows you is how much revenue turns into net income after all deductions. It's the percentage of total revenue that becomes profit once everything is subtracted. I'll share the formula next.

The Formula for ROR

The formula is simple: ROR equals net income divided by sales revenue. That's it—straightforward division to get your result.

How to Calculate ROR

To calculate it, divide net income by revenue, which gives you a decimal. Multiply by 100 to turn it into a percentage. This uses net income, which subtracts both cash and non-cash expenses like depreciation from revenues. It covers all business activities, including daily operations and one-off events like selling a building.

Revenue here means total sales or net revenue after accounting for returns and rebates. If a company reports net revenue, that's what appears on the top line of the income statement.

What Does Return on Revenue Tell You?

ROR, or net profit margin, lets you see how much profit a company makes from its sales, factoring in operating and overhead costs. It helps you evaluate management's effectiveness— they need to boost sales and revenue while keeping costs under control. ROR clarifies the balance between revenue growth and expense management.

If management increases revenue but costs rise even faster, ROR will drop. That means if expenses grow quicker than revenue, your net profit margin declines over time.

You can improve ROR by increasing revenue, cutting costs, or both. Another way is adjusting the sales mix— the proportion of products sold relative to total sales. Different products have different profit levels, so shifting to higher-margin items boosts net income and ROR.

For instance, imagine a sporting goods store selling an $80 baseball glove with $16 profit and a $200 bat with $20 profit. The glove gives 20% profit, the bat 10%. By focusing sales on gloves, the store increases net income per sales dollar, improving ROR.

ROR lets you compare a company's profitability year over year and assess management decisions. But since it ignores assets and liabilities, pair it with other metrics for a full financial evaluation.

ROR vs. EPS

When management boosts ROR, it often increases earnings per share (EPS) too. EPS measures profitability by dividing net income by outstanding common stock shares— higher EPS means the company looks more profitable.

Calculate EPS by dividing net income by shares outstanding. Say a company has $1 million net income and 100,000 shares— EPS is $10 per share. If net income rises to $1.2 million with no share change, EPS goes to $12, and ROR increases too. But ROR doesn't factor in shares.

Both metrics show profit generation. Companies issue shares to fund growth; if they turn that capital into high net income, management looks efficient. EPS reveals profit per share, favoring companies that generate more with fewer shares.

EPS shows how well management uses resources for profit, while ROR focuses on profit from revenue and cost management. Use both together to assess financial performance.

Real World Example of Return on Revenue

Look at Apple Inc.'s income statement for the fiscal year ending September 28, 2019, from their 10-K filing. Net sales were $260 billion, and net income was $55.2 billion. Apple's ROR is $55.2 billion divided by $260 billion, times 100, equaling 21%.

To judge if that's good, compare it to peers in the same industry and period. You can also track a company's ROR over multiple periods to see trends.