Operating Expense Ratio Formula

Updated on May 13, 2024
Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Operating Expense Ratio Formula?

The Operating Expense Ratio is the ratio between the cost of operation to the net revenue. It is typically used in evaluating real estate properties, where a higher Operating Expense ratio means higher operating expense than its property income and serves as a deterrent. Therefore, a lower operating expense ratio implies lower operating costs and is preferable and investment-friendly.

What Is Operating Expense Ratio Formula

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Operating expenses are required for operating a business. When we compare the cost of operation with the revenue generated, we get the operating expense ratio (OER). OER is popular in the real estate industry, and it is a common ratio used while doing real estate analysis. In real estate analysis, the analysts judge the cost of operating a property with the income generated by the property.

Key Takeaways

  • The operating expense ratio measures the relationship between operating costs and net revenue in real estate property evaluation.
  • A higher operating expense ratio indicates that operating expenses exceed property income, making it less appealing for investment. Conversely, a lower operating expense ratio signifies lower operating costs, which is advantageous and attractive to investors.
  • The operating expense ratio is a crucial tool in real estate analysis, allowing analysts to assess the profitability of a property by comparing operating costs to its income. It is widely used and favored in the real estate industry for making informed business decisions.

Operating Expense Ratio Formula Explained

This ratio is more useful in the real estate industry; let’s look at OER from that perspective.

In this ratio, there are two components.

  • The first component to calculate operating expense ratio is the most important one. It is operating expenses. In the case of the real estate industry, operating expenses include utilities, property management fees, maintenance, property taxes, insurance, repairs, etc.
  • The second component is the revenue. Revenues are the income generated from a specific property.

For example, a company has bought a property to rent out to other smaller companies. To find out how the property is doing, the company would look at OER.

  • If the operating ratio is higher, the company would consider keeping the property.
  • On the other hand, if the operating ratio is lower, the company would consider the property a great investment.

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Video on Operating Expense Ratio Formula

How To Calculate?

To calculate the operating expense ratio for financial analysis purposes, it is necessary to know the formula used for the calculation.

Here’s the formula for operating expense ratio –

Operating Expense Ratio = Operating Expenses / Revenues

In the above formula we notice that there are two different variables, the operating expense and the revenues. The operating expense refers to any expense made in the business related to its day-to-day operations or its core business activity. They may not be directly incurred in the manufacturing of its products and usually include salaries, wages, marketing and advertising expense, insurance, repair, maintenance, travel and entertainment, etc.  

The revenue is the amount earned from the sale of its goods and services in the market within a particular time period. It is the income earned from the primary business operation.

Here are a few steps to operating expense ratio calculation calculation properly:

Determine the operating expense – This is the most important step where the operating expenses should be correctly identified after gathering the value of each of them for a specific period. Then make a total of all such expenses for the numerator of the formula.

Net revenue calculation – Then comes the collection of data for the denominator. The net revenue is the total amount generated from sales after deduction of sales return, discount and any allowances. This data should be related to the same time period as the operating expense.

Plugging in the values – The next step is to put the values in their respective places, divide the operating expense by the revenue to get the ratio.  

Example

Let’s take a simple example to illustrate the operating expense ratio formula.

You can download this Operating Expense Ratio Excel Template here – Operating Expense Ratio Excel Template

Onus Inc. has been comparing its operating expenses for a property it bought and trying to find out the OER. Here’re the details –

  • Operating expenses – $40,000
  • Revenues – $400,000

Find out the OER of Onus Inc.

Using the operating expense ratio formula, we get –

  • OER = Operating Expenses / Revenues
  • Or, = $40,000 / $400,000 = 10%.

If we compare the ratio with the other companies in the same industry, we can interpret the OER correctly. Thus the above example not only shows in a very clear manner how to make the operating expense ratio calculation but also tells us that it can be used to make comparisons among companies.

Uses

The operating expense ratio formula is used heavily in the real estate industry. But that is not the only industry where it gets used. It is also used in the manufacturing industry and service industries.

  • Using OER  is to see how much income a company has been generating concerning its incurring operating expense.
  • Every company wants the OER to be lower. The lower the OER, the better the company is performing.
  • If you are looking at a company as an investor, you need to see the OER of the company for a long period.
  • If you look at the OER of a company for a long time, you will be able to discover a trend of how the ratio between operating expenses and revenues is getting shaped.
  • Then you can take that trend and compare it with the OER of other similar companies under the same industry.
  • If the OER of the target company is lower than other companies in the same industry, the target company can be the right company to invest in. However, it would be best if you also looked at other companies’ financial ratios before you decide..
  • OER measures the flexibility and competency of the managers of a company. Understanding this will help you a lot as an investor.

Calculator

You can use the following Operating Expense Ratio Calculator Calculator to make the procedure of the calculation easy and less time consuming..

Operating Expenses
Revenues
Operating Expense Ratio Formula
 

Operating Expense Ratio Formula =
Operating Expenses
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Revenues
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Operating Expense Ratio Formula in Excel (with excel template)

Let us now do the same example above in Excel.

This is very simple. You need to provide the two inputs of Operating Expenses and Revenues.

You can easily calculate the ratio in the template provided.

Operating Expense Ratio Formula in Excel

Frequently Asked Questions (FAQs)

1. What is a good operating expense ratio for a business?

A good operating expense ratio for a business depends on the industry and company’s specific circumstances. A lower ratio indicates better operational efficiency, as a higher proportion of revenue is retained as profit. However, what is considered “good” can vary, and it’s essential to compare ratios with industry benchmarks and historical performance for a more accurate assessment.

2. What is the importance of the operating expense ratio formula?

The operating expense ratio formula is crucial for evaluating a company’s operational efficiency and profitability. It helps assess the proportion of operating expenses to net revenue, providing insights into cost management and revenue generation. This ratio aids in making informed decisions, identifying cost-saving opportunities, and comparing financial performance with industry peers.

3. What are the limitations of the operating expense ratio formula?

While the operating expense ratio formula is valuable, it has limitations. It only considers operating expenses and does not include other financial factors such as interest, taxes, and non-operating income. Additionally, the formula may not be suitable for comparing companies of varying sizes or industries, as cost structures differ. Using the ratio alongside other metrics for comprehensive financial analysis is essential.

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This article has been a guide to what is Operating Expense Ratio Formula. We explain how to calculate it with example, uses with a calculator and formula in excel. We also provide you with an Operating Expense Ratio Calculator with a downloadable excel template.

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