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.

 

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