Loading the player...

What is the 'Operating Ratio'

The operating ratio shows the efficiency of a company's management by comparing operating expense to net sales. The smaller the ratio, the greater the organization's ability to generate profit if revenues decrease. When using this ratio, however, investors should be aware that it doesn't take debt repayment or expansion into account.

Operating Ratio

BREAKING DOWN 'Operating Ratio'

Analysts have many ways of analyzing performance trends. One of the most popular, because it concentrates on core business activities, is the operating ratio. The operating ratio is viewed as a measure of operational efficiency. It is often used, along with return on assets and return on equity, to measure a company's efficient use of capital and managerial resources. Analysts also like to track the operating ratio over a period of time to identify trends in operational efficiency or inefficiency. An operating ratio that is going up is indicative of an inefficient operating environment that might need to implement cost controls for margin improvement. An operating ratio that is decreasing is indicative of an efficient operating environment in which operating expenses are increasingly a smaller percentage of sales.

Operating Ratio Calculation

The operating ratio is calculated by dividing operating expenses by sales. Operating expenses are essentially all expenses except taxes and interest. Occasionally, a company has non-operating expenses as well, which are also deducted. All of these line items are listed on the income statement. Companies must clearly state which expenses are operational and which are designated for other uses.

Operating Ratio Example

Assume company A has $100,000 in sales; $50,000 in total expenses, including $3,000 in taxes; and $7,000 in interest payments. In this scenario, the operating expense is calculated by deducting taxes and interest payments from total expenses. The result is $50,000 minus $7,000 minus $3,000, for an amount of $40,000. The operating ratio is therefore $40,000 divided by $100,000, or 40%. This means that 40% of company A's revenues are used for operating expenses. The total expense ratio is calculated as $50,000 divided by $100,000, or 50%. This also happens to be net income margin.

Points of Consideration

It is important to compare the operating ratio with other firms in the same industry. If a company has a higher operating ratio than its peer average, it a robust indication of inefficiency, and vice versa. That said, some companies have taken on a great deal of debt. More leverage translates into additional risk with higher interest payments, but this risk is not evident in the operating ratio. Two companies can have the same operating ratio with vastly different debt levels, so it is important to compare debt ratios before coming to any conclusions.

  1. Efficiency Ratio

    Ratios that are typically used to analyze how well a company ...
  2. Combined Ratio

    Combined ratio is a measure of profitability used by insurance ...
  3. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ...
  4. Capitalization Ratios

    Capitalization ratios are indicators that measure the proportion ...
  5. Activity Ratios

    Accounting ratios that measure a firm's ability to convert different ...
  6. Working Ratio

    A ratio used to measure a company's ability to recover operating ...
Related Articles
  1. Investing

    Debt Ratios

    Learn about the debt ratio, debt-equity ratio, capitalization ratio, interest coverage ratio and the cash flow to debt ratio.
  2. Investing

    Key Financial Ratios for Retail Companies

    Using the following liquidity, profitability and debt ratios, an investor can gather deeper knowledge of a retail company's short-term and long-term outlook.
  3. Investing

    Understanding Leverage Ratios

    Large amounts of debt can cause businesses to become less competitive and, in some cases, lead to default. To lower their risk, investors use a variety of leverage ratios - including the debt, ...
  4. Investing

    The Price To Earnings Ratio Explained

    The price to earnings ratio is one of the most important ratios in investing. Find out how it is calculated, how it can be used and what it tells investors about a particular stock.
  5. Investing

    Key Financial Ratios to Analyze Tech Companies

    Understand the technology industry and the companies that operate in it. Learn about the key financial ratios used to analyze tech companies.
  6. Investing

    Payout Ratio vs. Retention Ratio: When to Use Which

    The payback ratio and retention ratio collect different information and are useful in different situations.
  7. Investing

    Key Financial Ratios to Analyze The Healthcare Industry

    Examine the health care sector and learn about significant financial ratios used by investors and analysts to evaluate health care companies.
  8. Investing

    Useful Balance Sheet Metrics

    These metrics can help you better understand the information found on balance sheets.
  9. Investing

    Liquidity Measurement Ratios

    Learn about the current ratio, quick ratio, cash ratio and cash conversion cycle.
  1. What is the difference between efficiency ratios and profitability ratios?

    Learn about efficiency and profitability ratios, what these ratios measure and the main difference between efficiency and ... Read Answer >>
  2. What is the expense ratio in the insurance industry?

    Learn about the expense ratio for insurance companies and the different methods of calculating it. Read Answer >>
  3. What are some ratios I can use the operating cash flow ratio with?

    Understand the importance of a company's operating cash flow. Learn about some of the financial ratios that use the operating ... Read Answer >>
  4. What other investment metrics are best used in conjunction with net margin?

    Learn about a number of other equity valuation measures that can best be used in conjunction with looking at a company's ... Read Answer >>
Hot Definitions
  1. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  2. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  3. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
  4. Income Statement

    A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
  5. Leverage Ratio

    A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt, or ...
  6. Annuity

    An annuity is a financial product that pays out a fixed stream of payments to an individual, primarily used as an income ...
Trading Center