Operating Ratio

Operating ratio is referred to as the ratio that depicts the efficiency of the management by establishing a relationship between the total operating expenses with the net sales.

Operating ratio is used to determine the efficiency of the management with which it is possible to generate a certain level of sales or revenue. It also helps in establishing how the company’s management is instrumental in reducing costs.

The total operating expenses of a company is based on two main components which are

a. Cost of Goods Sold and b. Operating expenses

The cost of goods sold components consist of factors like opening stock, direct expenses, manufacturing expenses and closing stock.

The operating expenses component include administration expenses along with selling and distribution expenses.

The formula for calculating Operational Ratio is discussed in the following lines.

Operating Ratio = Cost of Goods Sold (COGS) + Operating Expenses / Net Sales × 100

Where COGS = Operating stock + Net purchases + Manufacturing expenses – Closing stock

Or COGS = Net Sales – Gross Profit

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

Also, Operating Ratio + Operating Profit Ratio = 100

A smaller value or lower value of the ratio is recommended as it will make the company more efficient in generating revenue.

Rise in the value of the operating ratio is indicative of the decline in the efficiency.

Let us understand the operating ratio with the help of a solved example.

Solved Example

Q. Calculate the operating profit ratio for Maxwell Company with the following data

a.Net sales: ₹400,000

b.Cost of goods sold: ₹160,000

c.Administrative expenses: ₹35,000

d.Selling expense: ₹25,000

e.Interest charges: ₹10,000

Answer:

We know that,

Operating Ratio = Cost of Goods Sold (COGS) + Operating Expenses / Net Sales × 100

Now, as per the question, we have

Net Sales = 400,000

COGS = 160,000

Administrative and Selling Expense = 35,000 + 25,000 = 60,000,

Putting in the formula we get

Operating Ratio = 160,000+60,000/ 400,000 100

= 220,000/400,000 × 100

= 0.55 × 100

= 55%

This concludes our article on the topic of Operating Ratio, which is an important topic in Class 12 Accountancy for Commerce students. For more such interesting articles, stay tuned to BYJU’S.

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