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# Operating Ratio:

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The operating ratio is determined by comparing the cost of the goods sold and other operating expenses with net sales.

## Formula:

Following formula is used to calculate operating ratio:

[(Cost of goods sold + Operating expenses / Net sates)] × 100

Here cost of goods sold = Operating stock + Net purchases + Manufacturing expenses - Closing stock

OR

= Net sales - Gross profit

Operating expenses = Office and administrative expenses + Selling and distribution expenses

## Interpretation:

This ratio is a test of the efficiency of the management in their business operation. It is a means of operating efficiency. In normal conditions, the operating ratio should be low enough so as to leave portion of the sales sufficient to give a fair return to the investors.

Operating ratio plus operating profit ratio is 100. The two ratios are obviously interrelated. For example, if the operating profit ratio is 20%, it means that the operating ratio is 80%. A rise in the operating ratio indicates a decline in the efficiency.

Lower the operating ratio, the better is the position because greater is the profitability and management efficiency of the concern. The higher the ratio, the less favorable is the situation, because there will be smaller margin of profit available for the purpose of payment of dividend and creation of reserves.

## Example:

From the following details, calculate the operating ratio:

 Cost of goods sold 6,00,000 Operating Expenses 40,000 Sales 8,20,000 Sales returns 20,000

Solution:

Operating ratio = [(Cost of goods sold + Operating expenses) / Net Sales] × 100

= [(6,00,000 + 40,000) / 800,000*] × 100

= 640,000 / 800,000

= 80 %

*(8,20,000 - 20,000)

More study material from this to

## More study material from this topic:

 Meanings, Nature and Usefulness of Ratios Analysis Interpretation of Ratios Important Factors for Understanding Ratios Analysis Significance and Usefulness Ratios Analysis Classification of Ratios Analysis of Short Term Financial Position or Test of Liquidity Current Ratio Quick/Acid Test/Liquid Ratio Absolute Liquid Ratio Inventory/Stock Turnover Ratio Debtors / Receivable Turnover Ratio Creditors / Payables Turnover Ratio Working Capital Turnover Ratio Profitability Ratios Gross Profit Ratio (GP Ratio) Operating Profit Ratio Net profit ratio (NP ratio) Earnings Per Share Ratio Operating ratio Expense ratio Solvency ratios - Test of Long Term Solvency Debt-equity Ratio Debt Service Ratio or Interest Coverage Ratio Fixed Assets Ratio Debts to Total Funds or Solvency Ratio Reserves to Capital Ratio Capital Gearing Ratio Proprietary Ratio Accounting Ratios Formulas Limitations of Ratios Analysis

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