What Is the Berry Ratio?
The Berry ratio compares a company's gross profit to its operating expenses. This ratio is used as an indicator of a company's profit in a given period. A ratio coefficient of 1 or more indicates that the company is making a profit above all variable expenses, whereas a coefficient below 1 indicates that the firm is losing money.
- The Berry ratio is a financial ratio that compares a company's gross profit to its operating expenses.
- The ratio is an indicator of a company's profit in a given period; a ratio of 1 or more indicates that a company's profit is above operating expenses, while a ratio below 1 indicates that a company is losing money.
- Dr. Charles Berry was the economist that developed the Berry ratio as part of expert testimony during a 1979 transfer pricing court case between DuPont and the United States.
- The Berry ratio is used in transfer pricing but today is a seldom utilized ratio due to the unspecified nature of cost allocation in accounting.
Formula and Calculation of the Berry Ratio
To calculate the Berry ratio, you take gross profit, or gross margin, and divide it by operating expenses. The formula is as follows:
Berry Ratio=Operating ExpensesGross Margin
Gross margin is calculated as net sales or revenue minus the cost of goods sold. It indicates the amount of revenue a company retains after taking into account the direct costs to produce the goods or services that generated that revenue.
Operating expenses are the expenses that a company incurs during its normal course of business. This includes items such as rent, payroll, inventory, and equipment.
What the Berry Ratio Can Tell You
The Berry ratio is named after Dr. Charles Berry, an American economics professor who developed the method as part of expert testimony during a 1979 transfer pricing court case between DuPont and the United States.
The DuPont case involved a distributor who also performed related marketing services. Berry analyzed the performance of the distribution business. As part of his analysis, Berry compared the ratio of gross profit to operating expenses to the ratios of third-party companies that were comparable in nature.
In this manner, Berry managed to assess the return that the DuPont distributor earned on its value-adding distribution activities, though highlighting the assumption that the costs of these activities were part of the distributor’s operating expenses.
Since the early 1990s, the Berry ratio has been recognized in U.S. transfer pricing regulations. However, in practice, it has been little used. Most likely that is due to its long-time status as an unspecified method—considered by some as somewhat “shady”—and having been cited by some academics as being one of the most misused transfer pricing analysis ratios.
A company's financial health is difficult and near impossible to gauge with just one financial ratio. All companies should be evaluated using multiple data points to gauge their true financial profile.
Example of How to Use the Berry Ratio
Company ABC makes widgets. It sells its widgets for $10. In the first quarter of the year, ABC sold 1,000 widgets, bringing in revenue of $10,000. Now, the cost of creating these widgets includes the raw materials needed to make them, which amounts to $3 per widget. For 1,000 widgets, the cost of goods sold for the quarter is $3,000.
Company ABC has a gross margin of $7,000 ($10,000-$3,000) for all of the widgets it sold in the first quarter. Company ABC's operating expenses for the period totaled $1,500, which includes rent, employee wages, and inventory costs. The Berry ratio for this period would be gross margins ($7,000)/operating expenses ($1,500) = 4.7. This is significantly higher than 1, indicating that Company ABC is performing well in regards to profitability.
What Is a Good Berry Ratio?
A good Berry ratio, one that indicates financial strength, is 1 or above. The higher the Berry ratio, the stronger the profitability of the company.