Operating Expense Ratio is the ratio between the cost of operation to the net revenue and is typically used in evaluating real estate properties, where higher Operating Expense ratio means higher operating expense as compared to its property income and serves as a deterrent and lower operating expense ratio implies lower operating costs and therefore, preferable and investment-friendly.
Operating Expense Ratio Formula
Operating expenses are required for operating a business. When we compare the cost of operation with the revenue generated, we get operating expense ratio (OER).
OER is popular in the real estate industry, and it is a common ratio that is 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.
Here’s the formula for operating expense ratio –
Explanation of Operating Expense Ratio Formula
This ratio is more useful in the real estate industry; let’s have a look at OER from that perspective.
In this ratio, there are two components.
- The first component 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 ratioOperating RatioOperating Ratio refers to a metric determining how efficient a company’s management is at keeping operating costs low while generating revenues or sales, by comparing the total operating expenses of a company to that of its net sales. Operating Ratio Formula = Operating Expenses / Net Sales* 100 is higher, the company would think twice about keeping the property.
- On the other hand, if the operating ratio is lower, the company would consider the property as a great investment.
Example of Operating Expense Ratio Formula
Let’s take a simple example to illustrate the operating expense ratio formula.
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 will be able to interpret the OER properly.
Use of Operating Expense Ratio Formula
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 industry.
- The purpose of using OER is to see how much income a company has been generating in relation to the operating expense it is incurring.
- 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 of time.
- If you look at the OER of a company for long, you will be able to discover a trend of how the ratio between operating expenses and revenues are 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, you also need to look at other financial ratios of the companyFinancial Ratios Of The CompanyFinancial ratios are indications of a company's financial performance. There are several forms of financial ratios that indicate the company's results, financial risks, and operational efficiency, such as the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratio, stability ratios, and so on. before you decide.
- OER measures the flexibility and the competency of the managers of a company. Understanding this will help you a lot as an investor.
Operating Expense Ratio Formula Calculator
You can use the following Operating Expense Ratio Calculator.
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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.
Video on Operating Expense Ratio Formula
This article has been a guide to the Operating Expense Ratio formula, its uses along with practical examples. Here we also provide you with an Operating Expense Ratio Calculator with a downloadable excel template.