The working ratio is used to determine whether or not a company is able to recover its operating costs from its annual revenue.
A company with a working ratio of less than one is able to recover its operating costs, whereas a ratio of more than one indicates a company that is unable to recover its costs. A ratio of one occurs when a company’s annual gross income is equal to its total expenditure.
How is it calculated?
A company’s working ratio may be determined by dividing its annual expenses (excluding depreciation and debt expenses) by its annual gross income.
Looking at the above example, company ABC appears to be in much better shape than Company DEF. DEF’s working ratio of 1.03 indicates that the company is not able to recover its operating costs, which exceed its annual income. Conversely, ABC is healthy, with an annual income of more than double its operating expenses. Not that it is important to limit comparison of working ratio to companies belonging to the same industry.
Uses and analysis
Working capital is a variation on the working ratio and is calculated as: