﻿ Operating Income to Sales Ratio

# Operating Income to Sales Ratio

## Definition

The operating income to sales ratio is a performance measure that allows analysts to understand the results from operations before unrelated items are added or subtracted.  Investor-analysts will track this ratio over time, so changes in profitability can be quickly identified.

### Calculation

Operating Income to Sales Ratio = Operating Income / (Net Sales - Non-Operating Income)

Where:

• Net Sales = Gross Sales - Returns
• Non-Operating Income:  includes items related to the company's financial activities.

### Explanation

Operating performance measures allow the investor-analyst to understand how well a company is performing with respect to sales, margins, and profits.  The operating income to sales ratio removes the effects of non-operating income activities, providing a clear picture of the company's ability to generate profits through its core business operations. Examples of non-operating activities include:

• Gains and losses from investment activities
• Sales of property or assets
• Changes in currency exchange rates
• Any other gain or loss that is not related to the core operating activities of the business

The operating income to sales ratio is particularly useful when a company's sales have been declining and the business may be selling off the company's assets or investments to increase net income.  Ratios that decrease over time can indicate eroding margins.

### Example

Company A's financial statements were indicating a small increase in earnings before income taxes (EBIT) over time.  However, market analysts were concerned the company's margins were eroding due to a sharp decrease in their competitor's pricing strategy.

As the table below indicates, EBIT was slowly growing, but Company A also showed a steady increase in non-operating income.  When the analyst examined Company A's operating income to sales ratio, they confirmed the portion of income derived from operations decreased from 25.8% in Year 0 to 21.6% in Year 3.

 Year 0 Year 1 Year 2 Year 3 Sales Revenues \$25,000,000 \$26,250,000 \$27,563,000 \$28,941,000 Operating Expenses \$18,750,000 \$20,063,000 \$21,467,000 \$22,970,000 Operating Income \$6,250,000 \$6,187,000 \$6,096,000 \$5,971,000 Non-Operating Income \$750,000 \$900,000 \$1,080,000 \$1,296,000 EBIT \$7,000,000 \$7,087,000 \$7,176,000 \$7,267,000 Operating Income to Sales 25.8% 24.4% 23.0% 21.6%