Gross profit is the difference between how much you pay to deliver goods or services and how much you earn on sales. The gross margin is the amount you keep after paying expenses and usually is stated as a percentage. Return on sales measures your operating efficiency and is calculated by dividing your net income by sales. Return on sales, or ROS, also is shown in percentage terms.
A higher return on sales percentage and rising gross margin indicate successful growth at your company. They are reliable tools you can use to measure your growth compared to other companies in your industry. A decreasing ROS percentage or reduced gross margin indicates you are losing money and may be headed for financial troubles. Both forms of measurement record the profits your company ultimately enjoys. According to the website Principles of Accounting, both forms of recording profits typically are utilized to monitor company growth.
While return on sales and gross margin percentages are important tools to monitor your company's success, you must consider all the variables that go into the final numbers. Percentages can be tricky and do not tell the whole story. According to the website Principles of Accounting, the percentages reveal trends in your company sales and are not always strictly associated with actual dollar amounts. For example, if your manufacturing costs rise and you pass on the increase to your customers, your sales may actually decrease, while your profit margin rises.
You should use each method of profit measurement to fine-tune various aspects of your operations. The gross margin is one of the best reflections of your management team, according to the Finance Scholar.com. It shows a relationship between how your managers use labor and cost of goods to produce saleable inventory. Your return on sales gives you a clearer picture of your operations managers and how effectively they keep costs under control and how quickly they generate sales and turn around the inventory.
In addition to gross margin and return on sales, other factors play into your company's successful financial picture. Your operating margin, for example, may provide a clearer picture of your overall health, according to Morningstar. The operating margin is a percentage measurement that provides a picture of your profits after you've paid all the costs of doing business, including marketing, support staff and overhead like rent and utilities. Net margin, cash flow and return on assets all add to the complete picture of your business's effectiveness.
Linda Ray is an award-winning journalist with more than 20 years reporting experience. She's covered business for newspapers and magazines, including the "Greenville News," "Success Magazine" and "American City Business Journals." Ray holds a journalism degree and teaches writing, career development and an FDIC course called "Money Smart."