An expense ratio compares total expenses to total net sales for a given period of time. Expense ratios can cover all net income and expenses for a period, or they can cover expenses and net income pegged to specific products, departments or business units. A monthly expense ratio can reveal trends and cyclical patterns emerging throughout a fiscal or calendar year, providing useful insight for making monthly or annual budgeting decisions and profit projections.
1. Add up your total direct costs for the month, and include the cost of materials, inventory and any consumables used in production. Factor in any variable labor and overhead costs, such as piece-work employees and electricity for small-batch production facilities. If you are calculating a monthly expense ratio for a unit smaller than the entire organization, make sure to only include expenses that can be pegged to that unit.
2. Calculate your total indirect costs for the month. Indirect costs include virtually everything not classified as a direct cost. Include details such as administrative salaries, insurance, and utilities expenses that do not vary with production output.
3. Determine your gross sales for the month. Gross sales are all of the sales revenue that you brought in for the month from both cash and credit transactions. Do not include non-sales-related revenue, such as interest income and capital gains.
4. Subtract losses for refunds, product returns and shrinkage from your gross sales figure to determine your net sales. Net sales represent the actual value of assets brought into the company through sales activities. This differs from revenue, which does not consider real-world financial losses in the sales department.
5. Use the following formula to calculate your monthly expense ratio: (total expenses / net sales) * 100 For example, assume a company brought in $20,000 in sales for the month, lost $300 worth of sales income due to product returns, and incurred $5,000 in total expenses. The company's expense ratio for the month would come out to 25.38 percent ((5,000 / 19,7000) * 100). This means that the company's total expenses are equal to 25 percent of the value of net sales.
- Work with monthly data to obtain a more accurate figure. If you are working with raw annual data, divide total expenses by 12 to approximate a monthly figure. If you are projecting expenses for an incomplete month, use the previous month's data and any new trends in the current month to estimate final monthly expenses.
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