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Operating Ratio

 Measures how efficient the company is creating its products or services while keeping operating costs low.

If the operating ratio is below 1 that means the company is making money. The lower the operating ratio, the more efficient the company.

How to use operating ratio

An operation ratio of 0.5 means that the operating costs are $0,5 for each $1 in net sales.

  • Lower is better
  • Below 1 is considered healthy (always use industry average)
  • Can be very different between industries
  • Can be used to compare companies

Why do investors use operating ratio in their analysis

Shows if costs of creating products and or services is increasing or decreasing. The lower the operating ratio, the more efficient the company is creating products and services. 

Things to be aware of

  • Only compare with other companies in the same industry
  • You need COGS (Cost Of Goods Sold) to calculate operating ratio which is not always shown in the income statement
  • Does not consider debt

The three steps every investor should look at:

  • What is the current net operating ratio?
  • What is the long term trend?
  • How does it compare to the industry?

How to calculate operating ratio

  • Operating ratio = Operating expenses plus COGS \ Net sales]

[keypoint text=

Real life example

A real life example of Tesla. You need the following data to determine operating ratio:

COGS is not specified on the income statement so we use the following calculation:

  • (cost of revenue plus total operating expenses) / total revenue
  • ($12,700,000 plus $1,628,000) / $16,934,000 = 0.84
Penke

Tesla's operating costs are $0,84 for each $1 in net sales.

The operating ratio measures the efficiency of a company at keeping low costs while generating profits from sales. It compares the total operating expenses to the net amount of sales. The total operating expenses exists of:

  • COGS (materials, labour, rent of facility, repairs) 
  • Operating expenses (legal fees, marketing, wages, rent, maintenance/repairs)

Operating expenses are all the costs the company makes that are not directly tied to the production of the service or product.  Where COGS are costs that are directly tied to the production of a product or service.

Do note that COGS is not always available in the income statement. Some companies include COGS in the operating expenses while others list COGS separately. To make it even more confusing, COGS is also known as “costs of sales” and costs of sales is the same as costs of revenue.

The operating ratio tells you how efficient the company is creating its products or services while keeping prices low. In this case, a lower ratio is better. Higher or rising operating ratios might tell you that costs are rising while sales are not improving or staying the same.

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