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Operating Ratio

This ratio establishes the relationship between the cost of the goods sold plus other operating expenses to net sales. The lower the percentage of operating ration, the higher the net profit ratio.

Components: The first component is the cost of the goods sold which is arrived at as: Opening Stock + Purchases – Closing Stock + Direct Expenses connected with the purchases or manufacturing. The second major component is operating expenses which comprise of administrative expenses like salaries, rent, depreciation, directors’s fees, electricity, insurance, et., ad selling and distribution expenses like cash discount allowed, advertising, commission, bad debts and traveling expenses of salesmen etc. Interest expense fo general nature (e.g., interest on bills payable and interest on other short-term debts) is also included. We exclude the financial expenses like interest on long-term debts, sales discount, provision for taxation, provision for doubtful debts and other unusual and non-recurring expenses like preliminary expenses, donation, inauguration expenses and discount, commission, brokerage, publicity on the issue of shares and debentures etc.

Computation : It is computed as follows:

Operating Ratio = Cost of the Goods Sold + Operating Expenses / Net Sales x 100

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