Reading Financial Reports For Dummies, 4th Edition
Book image
Explore Book Buy On Amazon

You can test how efficiently a company runs its operations using financial reports to calculate its return on sales (ROS). This ratio measures how much profit the company is producing per dollar of sales. By analyzing the numbers in the income statement using ROS, you can get a picture of the company's profit per dollar of sales and gauge how much extra cash the company is bringing in per sale.

Remember that the firm needs that cash to cover its expenses, develop new products, and keep itself competitive. Investors also hope that, at some point in the future, they may even be paid some dividends. At the very least, investors want to be sure the company is generating enough cash from sales to keep itself competitive in the market through advertising, new product development, and new market development.

How to figure out ROS

To calculate ROS, divide the net income before taxes by sales. You can find both numbers on the income statement. Net sales (sometimes called net revenue) is the top number on the income statement. Net income before taxes is in the expense section of the income statement, just before tax expenses are reported.

Net income before taxes ÷ Sales = Return on sales

You can calculate Mattel's ROS based on information in its income statement for 2012:

$776,464,000 (Net income before taxes) ÷ $6,420,881,000 (Sales) = 12.1% (ROS)

Mattel made 12.1 percent on each dollar of sales. Compare that number with Hasbro's ROS using numbers on its income statement for 2012:

$335,999,000 (Net income before taxes) ÷ $4,088,983 (Sales) = 8.2% (ROS)

Hasbro made 8.2 percent on each dollar of sales.

Investors can use the ROS ratio to determine how much profit a company is making on a dollar of sales. In comparing Mattel and Hasbro, you can see why Mattel's P/E is higher: Mattel is getting considerably better return on sales than Hasbro.

The truth about profits with ROS

In reading analysts’ reports on Mattel and Hasbro, you will find that Hasbro's historical ROS has been about 7 percent, so the results for Hasbro show minimal improvement.

Mattel is stagnating with its efforts to improve operating income. Its ROS in 2001 was 12.5 percent, and it dropped to 11.8 percent in 2007, but that percentage was headed in the right direction in 2012, at 12.1 percent. Mattel wants to get back to its previous historical average of about 15 to 16 percent.

ROS is just one part of the puzzle. You need to fully analyze the information you see in the annual reports to find all the pieces and make a determination about whether to invest in a company. You also need to analyze a company's liquidity.

About This Article

This article is from the book:

About the book author:

Lita Epstein, MBA, enjoys helping people develop good financial, investing, and tax planning skills. She designs and teaches online courses and has written more than 40 books, including Bookkeeping For Dummies and Reading Financial Reports For Dummies.

This article can be found in the category: