Operating Cost Ratios

Ratios can be used to help measure the effectiveness over cost control. Operating costs can be monitored with the use of direct and indirect operating ratios. Examples of Direct Operating Ratios are:

Direct Labor to Sales = Direct Labor Costs / Sales

Direct Materials to Sales = Direct Materials / Sales

Factory Overhead to Sales = Factory Overhead / Sales

Indirect Operating Ratios can be computed for almost any itemized expense. Two examples are:

Computer Expenses to Sales = Computer Expenses / Sales

Travel Expenses to Sales = Travel Expenses / Sales

Example : Direct Labor Costs are $ 100,000 Factory Overhead is $ 200,000, Computer Expenses are $ 15,000 and Sales were $ 500,000.

Direct Labor to Sales = $ 100,000 / $ 500,000 = .20 or 20%

Factory Overhead to Sales = $ 200,000 / $ 500,000 = .40 or 40%

Computer Expenses to Sales = $ 15,000 / $ 500,000 = .03 or 3%

Operating cost ratios are often used by production managers to monitor trends and identify problems. If a significant change occurs, the problem must be identified as either internal (such as operations) or external (such as economic conditions). Since investors and other outsiders don't have access to operating information, operating ratios are rarely used outside the organization.