DEFINITION of Working Ratio
The working ratio is a financial ratio used to measure a company's ability to recover operating costs from annual revenue. A low, fractional working ratio is an indicator of a company's financial sustainability. A small figure indicates expenses are eating up a small chunk of the company's gross income and the company will have plenty of money to pay its bills. This ratio is calculated by taking the company's total annual expenses (excluding depreciation and debt-related expenses) and dividing it by the annual gross income:
Working Ratio=Annual Gross IncomeTAE−(Depreciation+Debt Expenses)where:TAE=total annual expenses
BREAKING DOWN Working Ratio
A working ratio is a litmus test for a company's financial sustainability. A working ratio below 1 implies that the company is able to recover operating costs, whereas a ratio above 1 reflects the company's inability to do so. A company that is unable to cover its operating costs for an extended amount of time may have trouble keeping operations open and staying open.
An Example of Working Ratio
XYZ Company makes widgets. It has been making widgets since the 1900s and is seen in the industry as a somewhat antiquated brand. Since XYZ Company hasn't spent very much money overhauling its machinery over the years, it is still using old technology to manufacture its widgets, which makes the process more costly due to constant maintenance costs. In addition, XYZ Company loses market share every year to its more modern competitors. XYZ Company's working ratio gets larger each year since its expenses go up and its income falls. Recently it rose above 1, and analysts predict it will continue to rise.