Operating Expense Ratio Formula

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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 operating expense ratio (OER).

OER is popular in real estate industry and it is a common ratio that is used while doing the 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 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 real estate industry, operating expenses include utilities, property management fees, maintenance, property taxes, insurance, repairs etc.
The second component is 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 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.

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Example of Operating Expense Ratio Formula

Let’s take a simple example to illustrate 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

Operating expense ratio formula is used heavily in real estate industry. But that is not the only industry where it gets used. It is also used in 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. Lower the OER, 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 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 company 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.