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Expense Ratios

For a better analysis of the operational efficiency of the firm, it is essential to find out the ratio fo each item of expense to net sales or each group of items to the net sales. Expense ratio is a step in this direction. It is also valuable for the purpose of finding out whether and to what extent expenses vary as between different periods. The expense ratios may be formulated as follows:

(i)    Operating Expense Ratio = Total Operating Expenses / Net Sales x 100
(ii)    Administration Expense Ratio = Total Selling and Distribution Expenses/Net Sales x 100
(iii)    Selling and Distribution Expenses Ratio = Total Financial / and Distribution Expenses / Net Sales x 100
(iv)    Financial Expenses Ratio = Total Financial Expense / Net Sales x 100
(v)    Materials Consumed Ratio :

It is computed as : Materials Consumed / Net Sales x100

This ratio indicates the efficiency/inefficiency in purchasing or utilizing the raw materials. It is expressed as a percentage.

(vi)    Conversion Cost Ratio: This ratio is of great use in the manufacturing business units. It indicates the efficiency of the production activities. It is expressed as a percentage and is calculated as :

All Manufacturing Expenses

Conversion Cost Ratio = (excluding Cost of Raw Material) / Net Sales x 100

Operating Profit Ratio
This ratio expresses relationship between operating profits and net sales. It is computed as:

Operating Profit Ratio = Operating Profit / Net Sales x 100

Operating profit means the excess of gross profit over operating expenses. Gross profit is the excess of net sales revenue over cost of the goods sold. Operating expenses include office and administrative expenses, selling and distribution expenses, cash discounts allowed, interest on bills payable and short-term debts, bad debts and so on. Net sales mean cash sales plus credit sales minus sales returns.

Objectives: The primary objective is to determine the operational efficiency of the management. SO operating profit does not include gains from and losses on non-operating items, e.g., profit or loss on sale of investments, rent income, interest income and so on. Interpretation: This ratio helps in knowing the amount of profit earned from regular business transactions on a sale of Rs. 100. And then what amount of sale sis left to cover non-operating  expenses, to pay dividends and to create general reserves. Higher operating profit ratio is an indicator of more efficiency of the operating management. The following factors increase the ratio namely: (i) higher gross profit, and (ii) less amount of operating expenses.

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