Operating Profit Ratio Analysis

Operating profit ratio analysis helps in judging the operation efficiency of the company in running the business. A higher ratio would imply that company is successful in managing and reducing the various costs associated with the operation of the business whereas lower ratio would indicate inefficiency on the part of top management and therefore it need to do introspection and take steps to improve it. Given below is the formula for calculating operating profit ratio –

Operating Profit/Net Sales*100

In the above operating profit is calculated as = Net sales – (Cost of goods sold + Administrative expenses + selling expenses + distribution expense), as one can see that operating profit does not include taxes

Net sales is calculated as= Gross sales – Return Inwards

It can be better understood with the help of an example, suppose the net sales of the company are 100000, cost of goods sold is 40000, administrative expenses are 15000, selling expenses are 10000 and distribution expenses are 5000.

Then operating profit ratio would be

30000 (100000 – (40000 + 15000 + 10000 + 5000))/100000 = 30 Percent

However if one changes any of the above cost it will lead to change in the ratio, let’s say cost of goods sold is changed from 40000 to 60000 than above ratio would fall to 10 percent.