Operating Profit Ratio
Operating profit ratio establishes a relationship between operating Profit earned and net revenue generated from operations (net sales). operating profit ratio is a type of profitability ratio which is expressed as a percentage.
Net sales include both Cash and Credit Sales, on the other hand, Operating Profit is the net operating profit i.e. the Operating Profit before interest and taxes. Operating Profit ratio helps to find out Operating Profit earned in comparison to revenue earned from operations.
Formula to Calculate Operating Profit Ratio
Note – It is represented as a percentage so it is multiplied by 100.
Operating Profit = Net profit before taxes + Non-operating expenses – Non-operating incomes
or
Operating Profit = Gross profit + Other Operating Income – Other operating expenses
Revenue From Operations (Net Sales) = (Cash sales + Credit sales) – Sales returns
Example
Ques. Calculate Operating profit ratio from the below information
| Sales | 6,00,000 |
| Sales Returns | 1,00,000 |
| Operating Profit | 1,00,000 |
Net Sales = Sales – Returns
6,00,000 – 1,00,000
= 5,00,000
Operating Profit = 1,00,000
Operating Profit Ratio = (Operating Profit/Net Sales)*100
(1,00,000/5,00,000)*100
= 20%
This means that for every 1 unit of net sales the company earns 20% as operating profit.
Alternatively, the company has an Operating profit margin of 20%, i.e. 0.20 unit of operating profit for every 1 unit of revenue generated from operations.
High and Low Operating Profit Ratio
This ratio helps to analyze a firm’s operational efficiency, a trend analysis is usually done between two different accounting periods to assess improvement or deterioration of operational capability.
High – A high ratio may indicate better management of resources i.e. a higher operational efficiency leading to higher operating profits in the company.
Low – A low ratio may indicate operational flaws and improper management of resources, it is an indicator that the profit generated from operations are not enough as compared to the total revenue generated from sales.
Short Quiz for Self-Evaluation
>Read Working Capital Turnover Ratio