Revenue returns are increased by increasing net income.
Return on revenue (ROR) is a measure of company profitability that is calculated by dividing net income by revenue.
A business can increase ROR by increasing profit with a change in sales mix or by cutting expenses. ROR also has an impact on a firm’s earnings per share (EPS), and analysts use ROR to make investment decisions.
Return on revenue uses net income, which is calculated as revenues minus expenses. The calculation includes both expenses paid in cash and non-cash expenses, such as depreciation. The net income calculation includes all of the business activities of the company, which includes day-to-day operations and unusual items, such as the sale of a building. Revenue, on the other hand, represents sales, and the balance is reduced by sales discounts and other deductions, such as sales returns and allowances.
Return on Revenue Explains Company Results
A corporation’s ROR allows an analyst or investor to compare profitability from year to year and evaluate management’s business decisions. When ROR decreases, it may indicate that expenses are rising, and an increasing ROR means that expenses are being handled efficiently. Since ROR does not consider a company’s assets and liabilities, it should be used in conjunction with other metrics when evaluating a company’s financial performance.
Examples of Sales Mix
A company can improve its ROR by increasing its net income. Changing the sales mix can increase net income. The sales mix is the proportion of each product a business sells, relative to total sales. Each product sold may deliver a different level of profit. Businesses measure the profit generated using profit margin (net income/sales). By shifting company sales to products that provide a higher profit margin, a business can increase net income and improve ROR.
Assume, for example, that a sporting goods store sells an $80 baseball glove that generates a $16 profit and a $200 baseball bat that produces a $20 profit. While the bat generates more revenue, the glove produces a 20% profit ($16 / $80), and the bat only earns a 10% profit ($20 / $200). By shifting the store’s sales and marketing effort to baseball gloves, the business can earn more net income per dollar of sales, which increases ROR.
Factoring in EPS
When management makes changes to increase ROR, the company’s decisions also help increase EPS. Assume that a firm earns total net income of $1 million per year and has 100,000 shares of common stock outstanding, and EPS is ($1,000,000 / 100,000 shares), or $10 per share. If senior management can increase net income to $1.2 million and there is no change in common stock shares, EPS increases to $12 per share. The increase in net income also increases ROR.
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