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) |
