Sales Returns to Gross Sales Ratio

Definition

The sales returns to gross sales ratio allows analysts to understand the extent of product returns by normalizing the quantity returned using gross sales.  The sales return to gross sales ratio provides insights into possible problems with a product's quality, price, or an increase in competition.

Calculation

Sales Returns to Gross Sales Ratio = Sales Returns / Gross Sales

Explanation

The sales returns to gross sales ratio allows the company's management team, as well as the analyst-investor, to understand if there is a problem with a company's product or return policy.  Lower ratios are desirable, and an increase in the sales returns to gross sales ratio can be indicative of the following:

  • A decline in product quality, resulting in an increase in returns as well as replacements.
  • A lowering of the perceived value of the product relative to competitive offerings.

A decline can also occur if the company changes its returns policy.  For example, if a company were to institute a new policy that provides consumers with the opportunity to ship returned items for free, the company could see an increase in this ratio.

As is the case with other sales ratios, the investor-analyst must take into consideration seasonal effects.  For example, a product may enjoy a higher than average level of sales in December, followed by a spike in returns in January.  For this reason, this metric is typically reported on a three or six month rolling average.

Example

Last year, Company A's process improvement team recommended a change to the specifications of their most popular product.  This change was aimed at improving the product's quality, thereby reducing returns under warranty.  The team took four measurements each year, using a six month rolling average to remove seasonal effects.  The table below shows the sales returns to gross sales ratio in the test year.

Test Year Month 1 Month 2 Month 3 Month 4
Sales Returns (6-Months) $149,000 $169,000 $187,000 $162,000
Rolling Sales (6-Months) $7,667,000 $8,834,000 $9,834,000 $8,167,000
Sales Returns Ratio 1.9% 1.9% 1.9% 2.0%

After instituting their quality control recommendations, the sales returns to gross sales ratio was measured once again.

Year 1 Month 1 Month 2 Month 3 Month 4
Sales Returns (6-Months) $174,000 $150,000 $120,000 $119,000
Rolling Sales (6-Months) $10,325,000 $8,575,000 $7,525,000 $7,350,000
Sales Returns Ratio 1.7% 1.7% 1.6% 1.6%

As the above table illustrates, the sales returns to gross sales ratio declined in each of the four months it was measured.  The team concluded the change in the product's specification had a positive effect on returns under warranty.

Related Terms

sales to administrative expense ratio, sales backlog ratio, sales to employee, sales to fixed assets, sales to working capital, maintenance to fixed assets ratio, accumulated depreciation to fixed assets ratio, gross profit index