What is Operating Ratio?
The Operating Ratio measures how cost-efficient a company is by comparing its operating costs (i.e. COGS and SG&A) to its sales.
How to Calculate Operating Ratio?
The operating ratio is calculated by dividing a company’s total operating costs by its net sales.
Sales represent the starting line item of the income statement (“top line”), whereas operating costs refer to the routine expenses incurred by a company as part of its normal course of operations.
Operating costs are comprised of two components: COGS and operating expenses:
- Cost of Goods Sold (COGS): Otherwise known as the “cost of sales”, COGS represent the direct costs incurred by a company from selling its goods or services.
- Operating Expenses (OpEx): Unlike cost of goods sold (COGS), operating expenses (or SG&A) are the costs not directly tied to how revenue is generated by a company, yet still have an integral role in its core operations.
| Direct Operating Costs (COGS) | Indirect Operating Costs (SG&A) |
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Operating Ratio Formula
The formula for calculating the operating ratio divides a company’s operating costs by its net sales.
While a company’s sales can be easily found on the income statement, calculating a company’s total operating expenses requires adding up the appropriate expenses, as well as potentially removing the effects of certain non-recurring items.
If a company’s operating ratio is 0.60, or 60%, then this ratio means that $0.60 is spent on operating expenses for each dollar of sales generated.
The remaining $0.40 is either spent on non-operating expenses or flows down to net income, which can either be kept as retained earnings or issued as dividends to shareholders.
