Operating Ratio

Posted in Finance, Accounting and Economics Terms, Total Reads: 149
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Definition: Operating Ratio

Operating ratio provides information on how much of a company’s operating cost is covered from its sales. Basically the ratio indicates the cost per sales dollar of operating a business.


The ratio can be written as:

Operating Ratio = Operating Expenses/Net Sales


Where Operating Expenses can be broken down to production expenses (COGS) and administrative expenses (costs that include general, administrative and selling expenses).


The smaller the ratio, the greater is a company’s ability to generate profit as it indicates that the cost to produce a good is less than the selling price or revenue from that product.


The operating ratio is useful only to know if the core business is profitable, as it gives information on how much a company makes out of making a sale after removing operational expenses. The ratio does not include debt payments and expansions hence it is not the perfect ratio to check for profitability since it cannot be applied to firms that are leveraged.


The operating ratio should be used when taking it for multiple period of time, as operating expenses can vary monthly. It is better to track the ratio depending on the sales pattern of a firm. For example if we look at a cola producing company, its operating ratio should be calculated for seasons when the sales happen.

 

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