Generically, return on sales (ROS) is an efficiency measure defined as.

ROS asks “How hard are we working each dollar of sales?” This is a pure income statement relationship. However, if ROS is used alone, we could infer its effect upon the balance sheet and the financial structure.

1. Profits. From the cumulative profit discussion, we know the company needs to expand its asset base to increase profits.
2. But management wants a small sales base. If they have a smaller top line, and produce average profits, they can keep ROS high.
3. Management will likely respond with a niche strategy: a) Playing in fewer segments lets them expand assets within the segments. For example, they could concentrate their starting products in low technology segments, or they could retire the low tech products and replace them with new, high tech products with the recovered capital. b) Similarly, sales will be near the overall industry average in a niche strategy. Although they give up some segments, they have higher sales in their target segments.
4. Management will avoid debt, and move to retire existing debt to reduce interest payments.
5. Plant investments will be relatively modest.
6. Management is under no pressure to minimize assets, particularly current assets.

ASSETS MINIMALLY INCREASED TO EMPHASISE ROS

ASSETS		LIABILITIES & OWNER'S EQUITY
Cash	$4,000	Accounts Payable	$9,100	7.0%
Accounts Receivable	$12,000	Current Debt	$10,400	8.0%
Inventory	$22,000	Long Term Debt	$19,500	15.0%
Total Current Assets	$38,000	Total Liabilities	$39,000	30.0%
Plant and equipment	$140,000	Common Stock	$50,700	39.0%
Accum. Depreciation	($48,000)	Retained Earnings	$40,300	31.0%
Total Fixed Assets	$92,000	Total Equity	$91,000	70.0%
Total Assets	$130,000	Total Liab. & O. E.	$130,000	100.0%

Trade-Offs

Regarding the trade-offs with other performance measures, we are modestly increasing assets, using a hefty increase in equity and reduction in debt. Profits are good, but not quite as good as with a pure emphasis on cumulative profit. Dividends are zero. Stock is diluted.

The implications for other performance measures include:

1. ROE: Falls because of increased equity.
2. Asset turnover: Flat or improves somewhat.
3. ROA: Improves:, therefore if ROS improves and asset turnover stays flat (worst case) , then ROA must improve.
4. Stock price: Flat. Gains in book value are offset by stock dilution and zero dividends.
5. Market cap: Increases. More shares at the original price.
6. Cumulative profit: Increases.
7. Market share: Flat. Gains in segments are offset by abandoning other segments.

In a basic sense, ROS forces management to emphasize efficiency. Related measures like ROA and cumulative profit improve in concert.

A board of directors would never impose ROS alone, although the overall affect is healthy upon the company. Used alone it has two important downsides. First, stockholders will be disappointed. Although market cap goes up, it is not because stock price improved, but because additional stockholders were added. Second, the company becomes a takeover target. It has such an attractive mix of debt and equity that a corporate raider could buy the company using its own debt capacity.