Whether you’re an experienced manager, a high-potential employee or a new hire, there are certain business acumen metrics that will help you excel in your role. Understanding each of these metrics allows an individual to make informed financial decisions, which is pivotal in the success of their organization. Lacking some or all of this knowledge can create barriers in a person’s decision-making process. Including – but not limited to – creating budgets, forecasting, and even managing costs.
Do you and your coworkers know enough about these crucial financial metrics?
Sometimes referred to as Operating Profit Margin, it expresses, as a ratio or percentage, how much of each dollar of sales revenue (after the expenses of running the business are taken out) drops to the bottom line as profit.
Return on Sales is often the most eye-opening metric for people honing their business acumen skills.
Here’s an example of how this works:
Let’s say an electronics retailer sells $1 million of products/services.
After they pay their operating expenses, they’re left with an Operating Profit (or EBIT) of $20,000.
Using the ROS formula (Operating Profit ÷ Net Sales), we can calculate this retailer’s Return on Sales to be 2 percent.
This may seem low, but according to a 2019 Stern School of Business at New York University study, that industry’s average is only 2.3 percent. That translates to $0.02 of profit per dollar sold.
Return on sales (ROS) is a ratio used to evaluate a company's operational efficiency.This measure provides insight into how much profit is being produced per dollar of sales. An increasing ROS indicates that a company is growing more efficiently, while a decreasing ROS could signal impending financial troubles. dollar of sales).
We’ll start at the top.
Revenue plays a major role in an organization’s ROS. And while the gut reaction to improving return on sales is to simply sell more, this doesn’t always translate to more profit.
What could that be?
With more units sold, a company may incur more variable costs to produce those units. This could offset the benefit of the additional revenue, keeping ROS the same.
At other times, a sales professional may use a discount as an incentive to close a sale. Although discounts can be a valuable bargaining tool, if used without an understanding of the discount’s effect on profits, it can be detrimental to an organization’s operating efficiency and profit (and thereby, ROS).
Another major factor in an organization’s bottom line is an unbudgeted expense. This is where ROS gets scary.
Let’s say that same electronics retailer unexpectedly had to repair their delivery vehicle, at a cost of $5,000.
How much more would they have to sell to offset that unexpected expense and keep their profit margin the same?
If they can cut the cost from somewhere else in the budget (i.e., save $5,000 by not moving ahead with a planned computer upgrade in order to apply that $5,000 to the vehicle repair), they don’t have to sell more to offset that expense. Their profit has been protected.
However, to keep their profit the same and sell more to offset that expense, here’s how it would look:
Unbudgeted Expense ($5,000) ÷ ROS (2%) = $250,000!
This is a perfect example of how an unbudgeted expense, even a relatively small one, can put a financial strain on an organization.
In order to calculate your organization’s ROS, you need to know the Net Sales/Revenue and EBIT (or Operating Profit). If your organization is publicly traded, check out the Income Statement (sometimes called the Statement of Operations or P&L (Profit & Loss) Statement) in the Annual Report or Form 10-K.
If you don’t have access to your organization's financial statements, talk to your finance team and see if they can give you these numbers or tell you the ROS percentage.
Once you have those numbers, you can use this calculator to compute the ROS percentage.
Now that you know your organization's ROS, use it to:
Return on Assets (ROA) is a financial ratio (Operating Profit divided by Total Assets) designed to measure how well a company is using its assets to generate profit.
Before diving any deeper, it’s important to understand the definition of assets.
The International Financial Reporting Standards (IFRS) Framework defines an asset as follows: “An asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.”
Some examples include:
Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets. ROA gives a manager, investor, or analyst an idea as to how efficient a company's management is at using its assets to generate earnings. Return on assets is displayed as a percentage.
Here’s an example of how that hypothetical electronics retailer’s ROA might look.
Let's assume that their Total Assets are valued at $400,000 and they have an Operating Profit of $20,000.
Using the ROA formula (Operating Profit ÷ Total Assets), we can calculate this retailer’s Return on Assets to be 5 percent.
Without context, this number is relatively useless.
There are a couple of ways to give this number more meaning.
First, it’s important to understand that ROA varies across different industries and sectors.
CSIMarket has an informative table that ranks Return on Assets by sector.
Industry benchmarks indicate retailers’ average ROA is 5.78 percent. In this case, our hypothetical electronics store is slightly below average.
Another way to contextualize this metric is with historical data.
If, in a previous period, that same retailer’s Total Assets equalled $350,000 and they had the same Operating Profit (EBIT) of $20,000, their ROA for that timeframe would be 5.71 percent.
While the Return on Assets metric only tells part of the story, we can begin to question why that additional $50,000 investment in assets didn’t translate to additional Operating Profit.
Every organization has slightly different line items on its financial statements. However, you can always find Total Assets (in some form) on the Balance Sheet.
Product-based organizations tally up cash and cash equivalents, accounts receivable, raw materials, inventory, finished products, and PP&E (sometimes using different terminology) as Total Assets. For service organizations, Total Assets might include cash and cash equivalents, accounts receivable, investments, PP&E, or other items.
Many manufacturing businesses require a lot of equipment, buildings, and machinery to operate. Perhaps a manufacturing business must purchase a new piece of equipment. This would increase the Total Assets (denominator) part of the equation. Hopefully, as a result of this upgrade, the company can create efficiencies in the manufacturing cycle, generating cost savings elsewhere, and increasing Operating Profit (numerator).
A business that provides a service can also become more efficient, perhaps with systems, software and technology, or in the way they staff projects, driving profitability up (numerator) and keeping only the PP&E necessary to operate (denominator).
Any time a company can do more with less, ROA will improve.
Find out from your company’s financial statements (or with the help of your partners in finance) the Total Assets and Operating Profit. Then you can use this calculator to determine your organization’s ROA.
See if your finance or leadership team can enlighten you (or a quick internet search) on the industry average ROA based on benchmarks. If your competitors are publicly held organizations, you can calculate their ROA and compare it, based on their financial statements.
Once you have context for how your ROA measures up, think about how to drive more efficiencies in the company. Challenge your team and peers to do more with less.
Gross Profit Margin is a metric used to assess a company's financial health and business model by revealing the amount of money left over from sales after deducting the Cost of Goods Sold (COGS).
Gross processing margin (GPM) is the difference between the cost of a raw commodity and the income it generates once sold as a finished product. Gross processing margins are affected by supply and demand. The prices for raw commodities and their processed versions fluctuate, creating an ever-changing spread between the raw inputs and the processed products.
There are three short answers for increasing your company’s GPM.
Those examples are a bit of an oversimplification. While selling more will increase Gross Profit Margin eventually, it is not an immediate way. This is because with more units produced (or services provided), there are also more costs to produce the units or perform the service. More sales will incrementally increase Gross Profit Margin, provided the costs do not match or exceed the sales.
The most direct and immediate ways of improving Gross Profit Margin are to lower COGS and raise prices.
Suppose you sell staplers for $8 each. The parts you require to build the stapler might cost you $4 (outer plastic casing - $2, internal metal frame and hinge - $1.50, and spring - $0.50).
This means your COGS is $4, which is 50% of your sale price (which also means you have a 50% Gross Profit Margin). Say you can renegotiate with your supplier for the outer plastic casing and buy in bulk, bringing the cost per unit down to $1 instead of $2.
Remember, Gross Profit Margin is only a starting point to measure a company’s profitability. In your stapler shop, you also have other operating expenses (the rent payment for your shop, electricity bills, your salary).
Once you deduct those costs, you arrive at EBIT (Earnings Before Interest & Taxes) or Operating Profit. And then you have a few additional expenses (like those taxes and interest).
At the end of the day, when ALL expenses are deducted, you arrive at your Net Profit (or Net Income).
That’s why it’s so important to maximize your Gross Profit - so that when all the other expenses come out later, you still have something left as your net.
Companies benchmark their Gross Profit Margin to stay competitive with other firms in their industries. This is especially important in manufacturing businesses. Many organizations focus on Continuous Improvement (or Lean Six Sigma or Kaizen) to streamline and reduce waste - in all areas of the business, but especially in COGS, to promote a healthier Gross Profit Margin.