What it means
The working ratio is widely used for organisations such as utilities, transport systems and local authorities, where operating costs and income need close watching. It is also used for ordinary businesses, usually calculated as operating costs divided by net sales.
The exact definition changes by sector, so it is important to know which version is being quoted. A common version divides cost of goods sold plus operating expenses by net sales.
Some public sector versions exclude depreciation, because depreciation is a non-cash charge, so that the ratio reflects the cash cost of operating. Whichever version is used, the same method must be applied across years to make comparisons meaningful.
The ratio tells managers and lenders how much room there is to cover debt payments and other costs. A ratio of 70% means 70 cents of each dollar of income goes on running costs, leaving 30 cents for interest, debt repayment and profit.
Ratios above 100% mean operating costs exceed income, so the operation is losing money before financing costs. Lenders often set targets for the ratio in loan agreements, especially in infrastructure.
A ratio that creeps up can be an early warning that costs are rising faster than prices. Comparing the ratio with similar organisations helps show whether costs are in line.
The nuance is that a very low ratio is not always good. It may mean the organisation is underspending on maintenance or staffing, which stores up bigger costs later.
It also does not capture borrowing costs or large one-off items, so it should be read alongside other measures. A working ratio is most helpful when tracked over time and against a clear target.
Plotting it quarterly, with seasonal swings in mind, shows whether cost growth is outpacing income, and a simple forecast can show how much of an expected price rise or cost saving is needed to hold the ratio steady. Many boards set an internal ceiling below any lender covenant, to leave a safety margin.
In practice
Real-world examples.
Example
A municipal water utility reports revenue of $40 million and operating costs, excluding depreciation, of $30 million. Its working ratio is 75%, and the board compares it with its loan covenant of 85% to confirm there is headroom.
Example
A bus operator sees its working ratio rise from 88% to 96% over two years because fuel and wages increased faster than fares. Finance proposes a fare review to bring the ratio back below 90%.
Example
A regional courier compares its working ratio with a competitor's published figure. Its own ratio of 82% against 78% shows it needs to tighten delivery costs.
Formula
Calculation
Working ratio = (cost of goods sold + operating expenses) / net sales x 100
Suppose a distribution company has net sales of $2,000,000, cost of goods sold of $1,200,000 and operating expenses of $300,000. Working ratio = (1,200,000 + 300,000) / 2,000,000 x 100 = 1,500,000 / 2,000,000 x 100 = 75%. That leaves 25% of sales, or $500,000, to cover interest, tax and profit.Case study
Seen in the real world.
Rivermead Transit is an illustrative, fictional local bus company with revenue of $12 million a year. Its lenders required the working ratio to stay below 90% as a condition of a vehicle loan.
When fuel prices rose, operating costs grew from $10.2 million to $11.4 million, lifting the ratio from 85% to 95%. The finance director warned the board before the covenant was tested and presented options: a fare rise, route changes or a fuel hedge.
The board combined a small fare rise with the withdrawal of two low-use routes, bringing costs down to $10.6 million on revenue of $12.1 million, a ratio of about 87.6%. In this illustrative case the early warning avoided a covenant breach and a renegotiation of the loan. The finance director now reports the ratio to the board every month alongside the cash balance.
Watch out
Common mistakes.
- Comparing working ratios calculated in different ways, for example one including depreciation and one excluding it.
- Treating a lower ratio as always better, when it may result from cutting maintenance that must be paid for later.
- Reading the ratio alone, without looking at debt service and profit after financing costs.
Questions
People also ask.
What is a good working ratio?
It depends on the sector, but a ratio comfortably below 100% is needed to make any operating surplus, and lenders often set a limit such as 85% or 90%.
Is the working ratio the same as the operating ratio?
They are closely related and sometimes used interchangeably, but definitions differ, so check the formula being used. A gap of several percentage points against similar organisations is a prompt to look at staffing, purchasing and maintenance spending.
Why do public bodies use it?
It shows how much income is left after running costs to repay debt and fund repairs. Lenders in particular like a simple test that can be checked against the published accounts every year.
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