Operating Ratio — A First Look
Think of a shopkeeper who earns ₹100 from sales. She spends ₹70 on buying goods, ₹15 on salaries and rent, and ₹5 on electricity. That leaves her with ₹10 as profit. Now ask: how much of every ₹100 sale is eaten up by her normal business operations? The answer is ₹90 (₹70 + ₹15 + ₹5). That 90% is her Operating Ratio.
In everyday language, the Operating Ratio tells you: "Out of every rupee of revenue from operations, how many paise go toward running the business?" The lower this ratio, the more efficient the business — because a smaller share of revenue is consumed by operating costs.
Precise Meaning (NCERT Definition)
The Operating Ratio is a profitability ratio that measures the proportion of Operating Cost to Revenue from Operations (Net Sales).
Operating Ratio=Revenue from OperationsOperating Cost×100
Where:
- Revenue from Operations = Net Sales (Gross Sales − Sales Returns)
- Operating Cost = Cost of Revenue from Operations + Operating Expenses
Cost of Revenue from Operations = Opening Inventory + Purchases + Direct Expenses − Closing Inventory
(For a trading firm, this is simply Cost of Goods Sold.)
Operating Expenses include:
- Office and administrative expenses (rent, salaries, insurance)
- Selling and distribution expenses (advertising, commission, carriage outward)
- Depreciation on fixed assets used in operations
Non-operating items are excluded. Do NOT include:
- Interest on loans (financial cost)
- Loss on sale of fixed assets
- Donations or charity
- Dividend paid
- Income tax
Why It Matters
A high Operating Ratio (say, above 90%) means the business has very thin margins from its core operations. A low ratio (say, 70%) indicates strong operational efficiency — more revenue is left as operating profit.
Managers use it to:
- Compare efficiency over time (trend analysis)
- Benchmark against competitors
- Identify where costs are rising out of control
Investors and creditors watch it because a rising Operating Ratio often signals trouble before net profit falls.
Accounting Treatment — Which Account is Debited/Credited?
The Operating Ratio is not a journal entry. It is a ratio computed from the Profit & Loss Statement. No account is debited or credited for the ratio itself.
However, the components that go into the ratio are recorded in the usual way:
| Component | Journal Entry (Debit/Credit) |
|---|
| Purchases | Debit Purchases A/c, Credit Cash/Supplier A/c |
| Salaries | Debit Salaries A/c, Credit Cash/Bank A/c |
| Depreciation | Debit Depreciation A/c, Credit Accumulated Depreciation A/c |
| Revenue from Operations | Debit Cash/Bank/Debtors A/c, Credit Revenue from Operations A/c |
All these expenses and revenues are then transferred to the Profit & Loss Account at the end of the year. The Operating Ratio is simply a mathematical relationship between two figures already sitting in that account.
Proforma / Format (as per NCERT) …