Operating Ratio

The operating ratio measures how efficiently a business manages its core operating costs. It tells you what percentage of revenue from operations is consumed by the cost of goods sold and the day-to-day expenses of running the business. A lower ratio is generally better, because it means a larger share of revenue is left over as profit.

The formula is:

Operating Ratio = (Cost of Revenue from Operations + Operating Expenses) / Net Revenue from Operations × 100

Both the numerator and denominator come directly from the Statement of Profit and Loss.

What goes into the numerator?

The numerator is the total cost of operations. It has two parts:

1. Cost of Revenue from Operations – This is the direct cost of the goods or services sold (opening stock + purchases + direct expenses – closing stock).
2. Operating Expenses – These are the indirect expenses needed to run the business. The textbook lists them as: office expenses, administrative expenses, selling expenses, distribution expenses, depreciation, and employee benefit expenses.

What is excluded from the numerator?

The cost of operation is determined by excluding all non-operating items. These are incomes and expenses that arise from activities outside the main business operations. Examples given in the text include:

• Loss on sale of assets
• Interest paid (on loans, debentures, etc.)
• Dividend received (from investments)
• Loss by fire
• Speculation gains

None of these are part of the operating cost. They are ignored when calculating the operating ratio.

What goes in the denominator?

The denominator is Net Revenue from Operations. This is gross revenue from operations minus any sales returns, trade discounts, and excise duty (if applicable). It is the actual revenue earned from the main business activity.

Interpreting the result …