Expenses Ratio and Operating Ratio
Chapter Thirty-Three
Syllabus topic 3, "Revenue Statement Ratio: i) Gross Profit Ratio ii) Expenses Ratio iii) Operating Ratio iv) Net Profit Ratio v) Net Operating Profit Ratio vi) Stock Turnover Ratio"
Pages 88 to 89 of 162
The expenses ratio
Expenses ratio = (A particular expense / Net sales) x 100
Computed for each expense separately, and for the total of the operating expenses. Expressed as a percentage. A falling ratio is favourable.
Worked on Sunrise
| 2026, Rs | 2026, per cent | 2027, Rs | 2027, per cent | |
|---|---|---|---|---|
| Administrative expenses | 90,000 | 5.62 | 1,00,000 | 5.00 |
| Selling and distribution expenses | 1,10,000 | 6.88 | 1,40,000 | 7.00 |
| Total operating expenses | 2,00,000 | 12.50 | 2,40,000 | 12.00 |
Specimen working: Rs 1,00,000 over Rs 20,00,000 times 100 is 5.00 per cent.
Interpretation
Administrative expenses fell from 5.62 to 5.00 paise in the rupee. A largely fixed cost spread over sales that grew 25 per cent must fall as a percentage, and it did. This is not a saving; it is the natural effect of growth, and saying so is better than praising it.
Selling and distribution rose from 6.88 to 7.00. That is the one adverse movement. A selling cost is a variable cost and should hold steady as a percentage of sales; rising means each rupee of sales cost more to win than it did.
The total fell from 12.50 to 12.00 and the fall conceals the two opposite movements, which is why MU asks for the expenses ratio expense by expense.
Which expenses go into it
All operating expenses, and only operating expenses.
| In | Out |
|---|---|
| Administrative expenses | Cost of goods sold, which has its own ratio |
| Selling and distribution expenses | Interest, which is a financing cost |
| Depreciation on business assets | Tax, which is an appropriation of profit |
| Non-operating expenses: loss on sale of an asset, loss by fire |
The operating ratio
Operating ratio = ((Cost of goods sold + Operating expenses) / Net sales) x 100
Expressed as a percentage. A lower ratio is better, because it is a cost ratio.
Worked on Sunrise
| 2026, Rs | 2027, Rs | |
|---|---|---|
| Cost of goods sold | 11,20,000 | 14,00,000 |
| Add: operating expenses | 2,00,000 | 2,40,000 |
| Total operating cost | 13,20,000 | 16,40,000 |
| Net sales | 16,00,000 | 20,00,000 |
| 2026 | 2027 | |
|---|---|---|
| Operating ratio | 82.50 per cent | 82.00 per cent |
Eighty-two paise of every rupee of sales is absorbed by the cost of running the business, leaving eighteen as operating profit.
The check
Operating ratio + Net operating profit ratio = 100
| 2026 | 2027 | |
|---|---|---|
| Operating ratio, per cent | 82.50 | 82.00 |
| Net operating profit ratio, per cent | 17.50 | 18.00 |
| Total | 100.00 | 100.00 |
Run this check every time. If the two do not total 100, either the cost of goods sold has been left out of the operating ratio or a non-operating item has been let in.
Interpretation
The operating ratio fell from 82.50 to 82.00, so half a paisa more of every rupee of sales survives as operating profit. The whole of the improvement is in the operating expenses, since the cost of goods sold held at exactly 70 per cent in both years.
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