The working ratio is a financial figure that shows either a business has an ability to cover its ongoing operating expenses within a given accounting period. Working ratio like many other financial ratios indicates the financial health of the business however it mostly yields an imprecise figure. This ratio is mostly used by the third party and the investors in order to find out the financial stability of the business so that they must invest in the business or not.
In order to find out the working ratio the total expense of the business are divided by the total revenue of that accounting period. However while calculating the expenses depreciation is not added in the total expenses instead it is subtracted from the total expenses. The formula of working ratio can be shown as under:-
Working Ratio = Annual Operating Expense – Depreciation/ Total Revenues
If the derived ratio is less than 1 that means the business is at least capable of recovering its expenses of that accounting period. If the derived ratio is greater than 1 that means the company is not able fulfill its expense for that accounting period. There are a number of reasons due to which the working ratio is not considered to be a reliable source of checking financial status of the business. The number one reason is that the working ratio does not include financing costs while calculation, the ratio of 1 is considered to be good however in actual it shows zero profitability for the business. In addition to that the denominator used in calculation is gross sales instead of it net sales must be used to see the affect of sales returns and allowances.
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