Operating Ratio

Definition:

Operating ratio is the ratio of cost of goods sold plus operating expenses to net sales. It is generally expressed in percentage.

Operating ratio measures the cost of operations per dollar of sales. This is closely related to the ratio of operating profit to net sales.

Components:

The two basic components for the calculation of operating ratio are operating cost (cost of goods sold plus operating expenses) and net sales. Operating expenses normally include (a) administrative and office expenses and (b) selling and distribution expenses. Financial charges such as interest, provision for taxation etc. are generally excluded from operating expenses.

Formula of operating ratio:

Operating Ratio = [(Cost of goods sold + Operating expenses) / Net sales] × 100

Example:

Cost of goods sold is $180,000 and other operating expenses are $30,000 and net sales is $300,000.

Calculate operating ratio.

Calculation:

Operating ratio = [(180,000 + 30,000) / 300,000] × 100

= [210,000 / 300,000] × 100

= 70%

Significance:

Operating ratio shows the operational efficiency of the business. Lower operating ratio shows higher operating profit and vice versa. An operating ratio ranging between 75% and 80% is generally considered as standard for manufacturing concerns. This ratio is considered to be a yardstick of operating efficiency but it should be used cautiously because it may be affected by a number of uncontrollable factors beyond the control of the firm. Moreover, in some firms, non-operating expenses from a substantial part of the total expenses and in such cases operating ratio may give misleading results.

You may also be interested in other articles from “financial statement analysis” chapter:

1. Horizontal and Vertical Analysis
2. Ratios Analysis
3. Horizontal Analysis or Trend Analysis
4. Trend Percentage
5. Vertical Analysis
6. Accounting Ratios Definition, Advantages, Classification and Limitations:
7. Gross profit ratio
8. Net profit ratio
9. Operating ratio
10. Expense ratio
11. Return on shareholders investment or net worth
12. Return on equity capital
13. Return on capital employed (ROCE) Ratio
14. Dividend yield ratio
15. Dividend payout ratio
16. Earnings Per Share (EPS) Ratio
17. Price earning ratio
18. Current ratio
19. Liquid/Acid test/Quick ratio
20. Inventory/Stock turnover ratio
21. Debtors/Receivables turnover ratio
22. Average collection period
23. Creditors/Payable turnover ratio
24. Working capital turnover ratio
25. Fixed assets turnover ratio
26. Over and under trading
27. Debt-to-equity ratio
28. Proprietary or Equity ratio
29. Ratio of fixed assets to shareholders funds
30. Ratio of current assets to shareholders funds
31. Interest coverage ratio
32. Capital gearing ratio
33. Over and under capitalization
34. Financial-Accounting- Ratios Formulas
35. Limitations of Financial Statement Analysis

Other Related Accounting Articles:

• Fixed Assets Turnover Ratio
• Expense Ratio
• Current Assets to Proprietor’s Fund Ratio
• Fixed Assets to Proprietor’s Fund Ratio
• Financial Accounting Ratios & Formulas
• Over trading and Under Trading
• Return on Shareholders Investment or Net Worth Ratio
• Working Capital Turnover Ratio
• Return on Equity Capital (ROEC) Ratio
• Proprietary Ratio or Equity Ratio