Expense ratios are particularly important when trying to determine how the operating expenses of a company directly affect their profits. It is a simple formula to calculate, and is done by taking the expenses ratio of a particular expense or group of expenses, and dividing this figure by the net sales. This calculation, gives you a clear idea of how sales are directly affected by a particular expense or group of expenses. Expense ratios are always expressed as a percentage.
- Skill level:
Things you need
- Trading profit and loss statement
- Pen & Paper
Calculate your net sales figure. This is done by taking your gross sales (the revenue earned by your business over a given period of time) and deducting your cost of sales (the costs directly related to your product). This figure can be found on your trading profit and loss statement. Example of a basic net sales calculation:
Sales £156,000 Less Cost of Sales £ 47,700 Less Direct Wages £ 32,000 Equals Net Sales £ 76,300
Divide your expenses by net sales. For example: expense divided by net sales, multiplied by 100 equals percentage ratio.
Repeat the above step for each expense or group of expenses you want to calculate. Expenses are costs that are not directly related to the product or service, but relate to the running of, and generation of business. For example, rent, light and heat, administration staff, insurances etc.
How to calculate an expense ratio
Tips and warnings
- Once you have the various calculations for your expenses or expense groups, the percentage you now have as a figure, is how this expense is directly affected by your sales.
- If this figure is derived from a fixed expense, the percentage value will change significantly. As your sales revenue increases the ratio percentage value will decrease, likewise if your sales revenue decreases then this ratio will increase. If the figure is derived from a variable there won’t be much fluctuation in the percentage.
- As a business the expense ratio is a useful tool to protect your net profit.
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