Efficiency - Expense Ratio

What it measures: Efficiency

How efficient / productive a firm is in producing revenue; the level of expenses within a firm relative to the revenue of the firm;

Information drawn from the Income Statement;

Represented as a percentage.

The equation:

Expenses / Sales x 100

What the result means:

The percentage of sales (revenue) that is consumed by business expenses (administrative, operational, financial). Businesses that generate revenue with the least amount of expenses is the most efficient. 

Lower results in the Expense Ratio are good; this results in higher net profit for the firm. 

Firms with high or increasing results in the Expense Ratio must focus upon their costs to improve efficiency. 

Reductions in the Expense Ratio lead to proportional improvements in the Net Profit Ratio - with the converse also being true.

Sample Statement:

Expenses ($77,000) / Sales ($300,000) x 100 = 25%

The firm has an Expense Ratio result of 25%. This means that 25% of all sales revenue is consumed by the administrative, operational and financial costs of the firm. Different industries have different costs bases; comparative ratio analysis is required to better determine this isolated result. The firm could lower this result by analysing each cost and finding alternatives to minimise expenses.

How to Improve the Expense Ratio:

• Cost controls (cost centres and expense minimisation programs)

• Operations Strategies such as better technology to decrease costs, lift productivity and minimise waste

• Human Resources audit of task design and performance appraisals to identify organisational inefficiencies