What is Operating Ratio?
An operating ratio demonstrates how effectively a company’s management controls expenditures while producing income or sales. It reflects the management effectiveness of that business and is done by comparing a company’s total operating expense to net revenues. So, the lower the operating ratio, the more efficiently a corporation generates income compared to overall expenses.
Significance of Operating Ratio in E-commerce Logistics
The operating ratio plays an important role in businesses as it depicts the efficiency of the management in generating more revenue. Some of its key benefits are:
- Operational efficiency indicator: The operating ratio helps to determine whether a corporation is effective at managing its expenses by comparing its operational expenses to its revenue. A low operating ratio is a good sign of a leading business.
- Facilitates time management: Over a particular time frame, the operating ratio gives a better idea of time management by comparing the operational abilities of the company during a time period.
- Improves financial conditions: The operating ratio gives an analysis of the expense to that of income or revenue, which enhances the financial stability of the organization.
Pre-requisites for Operating Ratio and How It Works
Specific requirements should be fulfilled to calculate the operating ratio, which is as follows:
- Calculating the total cost of goods sold (COGS) in a year.
- Additionally, calculating the operating expenses and net sales.
Finally, the formula for this ratio is as follows:
Operating ratio = (Cost of goods sold + operating expenses) / Net sales
Use Case With Operating Ratio
Let us consider a company that reports a net sale of 50 million AUD for a particular period. For the same time frame, the total cost of goods sold was 35 million AUD, while the total operating expenses were 10 million AUD.
Therefore, the operating ratio will be:
(35 + 10) / 50 = 0.9 or 90%.
Hence, 90% of the company’s net sales are operating expenses.