What is Operating Expense Ratio?
Operating expense ratio provides the reasons to the changes in the profit margin ratio. The ratio is computed by dividing operating expenses namely cost of goods sold plus selling expenses and administrative expenses.
Operating Expense Ratio Formula
Operating Expenses Ratio = Operating Expenses/ Sales
Example of Operating Expense Ratio
Suppose ABC company has operating expenses equals to Rs. 15,000. Company is able to sell the goods of Rs. 17,000. Compute operating expenses ratio?
Operating Expenses Ratio = 15,000/17,000
= 0.88 or 88%
This implies that 88% of the sales have been consumed together by cost of goods sold and other operating expenses. And the rest 12% sales have been left to cover interests, taxes and earnings to owners. A firm may decompose the operating expense ratio into –
- Cost of goods sold ratio is equals to cost of goods sold/sales
- Other operating expense ratio is equals to other operating expense/sales.
Interpretation of Operating Expense Ratio
A higher operating expenses ratio is unfavorable since it will leave a small amount of operating incomes to meet interest, dividends, etc. Moreover, it is also a yardistick of operating efficiency. However one should use it very cautiously. It is affected by number of factors such as uncontrollable factors, internal factors, employees and managerial efficiency. Furthermore, it also indicates the average aggregative variations in expenses. Here some of the expenses may be increasing and some may be falling.
In order to know the behavior of specific expense items, the ratio of each individual operating expense to sales should be calculated. These ratios when compared from year to year for the firm will throw light on managerial policies and programmes. For example, the increasing selling expenses, without a sufficient increase in sales, can imply uncontrolled sales promotional expenditure, inefficiency of marketing department, etc.
It is also very important that the expense ratio of the firm should be compared to those firms who belong to the same industry. In addition to this, the period of comparison should also need to be same.