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).

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

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:

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) …