What it means
Revenue is the money a business takes in from selling goods or services, before any costs are deducted. Profit is what is left after costs, interest and tax.
Return on revenue connects the two, telling you what share of each sale ends up as profit. A company with revenue of $2,000,000 and net profit of $150,000 has a return on revenue of 7.5%.
This means it keeps 7.5 cents from each dollar sold, and spends the other 92.5 cents on costs and taxes. Managers use the ratio to see whether growth in sales is actually adding to profit.
The ratio varies widely by industry. Supermarkets operate on thin margins but turn over their stock quickly, whereas software firms may have very high margins but require heavy spending on development.
Comparing a business with its own history and with similar companies is more meaningful than judging the number in isolation. Several levers can improve it.
Raising prices, cutting costs, changing the product mix and reducing waste all lift the ratio. However, a higher margin on fewer sales can leave total profit lower, so return on revenue should be read together with revenue growth and profit in dollars.
Definitions differ slightly. Some businesses use operating profit or pre-tax profit instead of net profit, which gives an operating margin or pre-tax margin.
When comparing figures from different sources, check which profit measure sits in the numerator. Seasonal and one-off items can distort a single period.
A big property sale, a legal settlement or a quiet quarter can swing the ratio, so many analysts look at the trailing twelve months, which smooths those effects and gives a steadier guide to the underlying margin.
In practice
Real-world examples.
Example
A building contractor wins a $6,000,000 contract and earns a net profit of $300,000 on it. The return on revenue is 5%, which is in line with typical margins for the sector, so the contractor accepts similar jobs. He also notes that a 1 percentage point fall in margin on a job this size would cost $60,000.
Example
An online subscription business has revenue of $10,000,000 and net profit of $2,500,000. Its return on revenue of 25% is high, and the owners use it to argue that more spending on marketing would still leave a healthy margin.
Example
A clothing retailer sells $4,000,000 of goods in a year but heavy discounting leaves net profit at $80,000. Return on revenue is 2%, and the buyer decides to cut the number of lines that rely on large markdowns. Management also sets a floor price below which no item may be discounted.
Formula
Calculation
Return on revenue = Net profit / Revenue x 100
Suppose a cafe chain has annual revenue of $2,000,000 and net profit of $150,000. The return on revenue is $150,000 / $2,000,000 = 0.075, or 7.5%. If a cost-saving project adds $40,000 to profit without changing sales, the new figure is $190,000 / $2,000,000 = 9.5%.Case study
Seen in the real world.
Tidewater Bakeries is an illustrative, fictional company that doubled its revenue in two years by opening new shops and supplying supermarkets. The owner was delighted with the growth until the accountant showed that net profit had barely moved.
Return on revenue had fallen from 9% to 4%, because supermarket contracts carried lower prices and the new shops had high rents. The accountant calculated that some contracts were earning only 1 cent of profit per dollar of sales. She also pointed out that delivery costs for the supermarket orders had been left out of the original price calculations.
In this fictional case the owner renegotiated prices, closed two weak shops and focused on the most profitable products. The illustrative lesson is that revenue growth only helps when the profit margin holds up, so the ratio should be watched alongside sales. The owner now reviews the margin on every new contract before signing it.
Watch out
Common mistakes.
- Celebrating higher revenue without checking whether the profit margin has fallen.
- Comparing margins between industries with very different cost structures.
- Mixing profit measures, such as comparing a net margin with another firm's operating margin.
Questions
People also ask.
Is return on revenue the same as net profit margin?
Yes, in most uses the two terms mean the same thing, which is net profit divided by revenue.
What is a good return on revenue?
It depends on the industry, so compare a company with its own past results and with similar businesses.
How can a business improve its return on revenue?
It can raise prices, reduce costs, improve the product mix or cut waste, and it should check that these steps do not cut total profit, since a higher margin on fewer sales can leave the business worse off.
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