Expense ratio is a profitability ratio, related to sales which can be computed by dividing expenses by sales.
Here the term expenses includes:-
i) Cost of goods sold
ii) Administrative expenses
iii) Selling and distribution expenses
iv) Financial expenses
The expenses ratio is closely profit margin, gross as well as net. It is very important for analyzing the profitability of a firm. A low expenses ratio is favourable whereas a high expenses ratio is unfavourable. The implications of a high expenses ratio is that only a relatively small percentage share of sales is available for meeting financial liabilities like interest, tax & dividends and so on.
Thus, an increase in a company’s expenses ratio would leave the company in a financial crunch.
An analysis of the factors responsible for a low ratio may reveal changes in the selling price on the operating expenses. It is likely that individual items may behave differently.
While some operating expenses may show a rising trend, others may record a fall. The specific expenses ratio for each of the item of operating may be calculated. These ratios would identify the specific cause.
To, illustrate, an increase in selling expenses may be due to a number of reasons like:
i) General rise in selling expenses.
ii) Inefficiency of the Marketing department leading to uncontrolled promotional and other expenses.
iii) Growing competition.
iv) Ineffective advertising.
v) Inefficient utilization of resources.