Operating Expense Ratio
The financial ratio known as the operating expense ratio, or OER, is considered a measurement of management efficiency. Using information found on the income statement, this metric looks at the ratio of operating expenses to net sales.
Operating Expense Ratio = Total Operating Expenses / Revenues
While management can take certain actions to control expenses, the price of a product or service is typically a function of market demand. The operating expense ratio allows investors and analysts to understand how efficiently a business is able to produce goods or supply services.
When viewed over time, the operating expense ratio can also reveal if management is able to expand operations without dramatically increasing expenses. If revenues were to expand year-over-year and the OER goes down; this would indicate that management is able to scale production efficiently; revenues expanded more quickly than expenses increased. This is a very positive outcome from a profitability standpoint.
When drawing conclusions about the relative performance of a company, benchmark comparisons should be made with competitors in the same industry.
Company A’s income statement in the current year indicates revenues of $29,611,000 and total operating expenses of $23,433,000. For the prior year, Company A reported revenues of $26,662,000 and total operating expenses of $20,744,000. The operating expense ratio for these two years would be:
= $20,744,000 / $26,662,000, or 0.79 for the prior year
= $23,433,000 / $29,611,000, or 0.78 for the current year
As Company A expanded revenues, its operating expense increased at a slightly slower rate, which means management was able to achieve some scaling of operations.