Formula of Operating Ratio
Operating Ratio =
or
Where,
1. Cost of Revenue from Operation (C.O.G.S) = Cost of Material Consumed + Purchase of Stock-in-Trade + Change in Inventories of Finished Goods and Work-in-Progress + Direct Expenses, or
2. Cost of Revenue from Operation (C.O.G.S) = Net Revenue from Operations – Gross Profit
3. Operating Expenses = Employee Benefit Expenses* + Depreciation and Amortisation Expenses + Other Expenses**
*Employee Benefit Expenses include Wages (Direct Expenses) + Salary + Staff Welfare Expenses etc.
**Other Expenses include Selling & Distribution Expenses (Advertisement, Discount, Bad Debts, etc.) + Office and Administration Expenses (Postage, Stationary, Rent, Printing Expenses, Insurance, Repair, etc.)
(Expenses like Loss on Sale of Assets/Investment are included in Other Expenses, but it is a Non-Operating Loss.)
Significance of Operating Ratio:
The Operational efficiency of the business is measured by operating ratio. The revenue from the operation is compared to the operating cost of the enterprise to know about the percentage of revenue absorbed by the costs. Operating ratio and operating profit ratio are complementary to each other, which means that the lower the operating ratio, the higher the operating profit ratio. Both are calculated in percentage form. A lower operating ratio is considered better. Also, if all the items related to operating costs are studied separately, the management can figure out the areas that require attention.
Illustration 1:
From the following information compute the operating ratio of Geeks Ltd.:
Solution:
Cost of Revenue from Operations = Cost of Material Consumed + Change in Inventories of Finished Goods and W.I.P
= 12,50,000 + 1,00,000
= ₹13,50,000
Operating Expenses = Employee Benefit Expense + Selling Expenses + Administrative Expenses + Other Expenses
= 60,000 + 40,000 + 30,000 + 1,00,000
= 2,30,000
Operating Ratio =
=
=
= 63.2 %
Therefore, Operating Ratio = 63.2 %
Illustration 2:
Using the following information, compute the operating profit ratio for GFG Ltd.:
Revenue from Operations : ₹18,00,000
Operating Expenses : ₹1,80,000
Gross Profit 25% on Cost.
Solution:
Calculation of Cost of Revenue from Operation:
Let Cost of Revenue from Operation be ₹100
Therefore, Gross Profit = ₹25, Revenue from Operation = ₹125
If Revenue from Operation is ₹125, Cost of Revenue from Operation = ₹100
If Revenue from Operation is ₹18,00,000,
Cost of Revenue from Operation =
Operating Ratio =
=
=
= 90%
Therefore, Operating Ratio = 90 %