Operating Ratio Formula

What is the Operating Ratio Formula?

The operating ratio formula is the ratio of the company’s operating expenses to net sales, where operating expenses include administrative expenses, selling and distribution expenses, cost of goods soldCost Of Goods SoldThe cost of goods sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company.read more, salary, rent, other labor costs, depreciation, etc. It is also called the operating cost ratio or operating expense ratio. The ratio is generally expressed in percentage terms. The lesser the operating ratio, the better it is for the company. It is because a lower ratio indicates it is carrying out its operations efficiently.

The cost of goods sold is added to operating expensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.read more to find out the operating ratio.

Operating Ratio Formula = Operating Expenses / Net Sales* 100
Operating-Ratio-Formula

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Source: Operating Ratio Formula (wallstreetmojo.com)

Explanation

In order to calculate the operating ratio in case the operating expenses include the cost of goods sold, the following steps are to be undertaken.

  1. Aggregate all the operating expenses.

  2. Find out the net salesThe Net SalesNet sales is the revenue earned by a company from the sale of its goods or services, and it is calculated by deducting returns, allowances, and other discounts from the company's gross sales.read more. In order to find net sales, certain items such as goods returned are deducted from the gross salesThe Gross SalesGross Sales, also called Top-Line Sales of a Company, refers to the total sales amount earned over a given period, excluding returns, allowances, rebates, & any other discount. read more.

  3. Use the following to find the operating ratio:

    Operating Ratio Formula = Operating Expenses / Net Sales * 100
    In certain cases, the cost of goods sold is given separately from operating expenses. In such cases, the cost of goods sold is added to operating expenses.

Calculation of Operating Ratio

The following examples will give us more clarity on the subject matter.

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

Example #1

The net sales for Blue Trust Inc. are $5,000. The operating expenses are $3,000. The cost of goods sold, which are not included in the operating expenses, is $1,000. Calculate the operating ratio for the company.

Solution

Use the below-given data for calculation of the operating ratio

  • Operating Expenses: 3000
  • Cost of Good Sold: 1000
  • Net Sales: 5000

Therefore, the calculation of operating ratio is as follows,

Example 1.1png

=(3000+1000)/5000

Operating Ratio Formula Example 1.2png
  • The operating ratio for Blue Trust Inc. is 80%.

Example #2

The Cost Accountant of Radley Inc. was going through its records. He found out that the following expenses were incurred in January:

  • Sales & Marketing Expenses: $400
  • Salary: $1,000
  • Repair & Maintenance Costs: $500
  • Direct Material: $600
  • Direct Labor: $1,200
  • Office Supply Costs: $300
  • Rent of Factory: $500

The sales were $11,000, and the sales returns were $1,000. Calculate the operating ratio.

Solution

First, we need to calculate Net sales

Net sales

Operating Ratio Formula Example 2.1
  • = $11,000 – $1,000
  • Net Sales = $10,000

Operating Expenses

Operating Ratio Formula Example 2.2

=$400+$1000+$500+$600+$1200+$300+$500

  • Operating Expenses = 4500

Therefore, the calculation of operating ratio is as follows,

Operating Ratio Formula Example 2.3

=4500/10000*100%

Operating Ratio Formula Example 2.4

Note

Interest expenses are not added as they are not operating expenses.

Example #3

An Economist is comparing the operating ratios of different firms in the same industry. He gets the following data: Calculate the operating expenses for each of these firms. Which firm has the highest degree of operating efficiency?

Firm Net SalesOperating Ratio
A$50,00060%
B$10,00070%
C$40,00050%
D$10,00080%
E$100,00070%
F$60070%
G$20,00040%

Solution

Therefore, Operating Expenses can be calculated using the below formula as,

Operating Expenses = Operating Ratio * Net Sales

Example 3.1

=60%*$50000

  • Operating Expenses = 30000

Similarly, we can calculate operating expenses for firms B, C, D, E, F, and G.

Example 3.2
The firm with the lowest operating ratio has the highest degree of operating efficiency. Firm G has the lowest operating ratio from these firms. Hence, firm G has the highest degree of operating efficiency.

Calculator

You can use this calculator

Operating Expenses
Net Sales
Operating Ratio Formula
 

Operating Ratio Formula=
Operating Expenses
X100
Net Sales
0
X100= 0
0

Relevance and Uses

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