Working Ratio - Explained
What is a Working Ratio?
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Table of ContentsWhat is a Working Ratio?How is a Working Ratio Used?An example for Working RatioAcademic Research on Working Ratio
What is a Working Ratio?
The working ration is an accounting ratio that determines if a company can recover operating expenses from its yearly revenue. If the working ratio is low, it signifies that the firm is financially sustainable. A lower value represents a small portion of the gross income of a company will be used to pay its expenses, and then, the company will still have lots of money for making due bill payments. This ratio is ascertained by considering the total expenses for a year, and then dividing it by the gross income for that year. The expenses should not include depreciation and debt-related costs.
Back to: ACCOUNTING, TAX, & REPORTING
How is a Working Ratio Used?
A working ratio can work as a litmus test for knowing the financial position of a company. If the working ratio of a company is less than 1, it means that it will be able to recover its operating or day-to-day expenses easily. In case, it is more than 1, it states that it will not be possible for the company to recover its operating expenses. If this continues for a longer time period, it may affect the productivity and operations of the company.
An example for Working Ratio
XYZ Company has been making widgets since the 1900s. In spite of being in the industry for so long, the firm doesn't adapt to the changing environment, and resists being in sync with the modern technology. They don't use modern equipment to have an edge over its competitors. This traditional approach makes them spend too much on maintaining and repairing their old equipment. Even, they tend to lose market share every year to its rivalries. As a result, their expenses keep rising, and they lack enough funds (income) to pay for these expenses. As per the recent calculation, their working ratio went beyond 1, and analysts believe that it will keep increasing.
Academic Research on Working Ratio
- The merchandising ratio: A comprehensive measure of working capital strategy, Cote, J. M., & Latham, C. K. (1999). The merchandising ratio: A comprehensive measure of working capital strategy. Issues in Accounting Education, 14(2), 255-267.
- Alternative accounting measures as predictors of failure, Beaver, W. H. (1968). Alternative accounting measures as predictors of failure. The accounting review, 43(1), 113-122.
- The accounting assessment of competitive position, Simmonds, K. (1986). The accounting assessment of competitive position. European Journal of marketing, 20(1), 16-31.
- Some empirical bases of financial ratio analysis, Horrigan, J. O. (1965). Some empirical bases of financial ratio analysis. The Accounting Review, 40(3), 558.
- Improving the communication function of published accounting statements, Smith, M., & Taffler, R. (1984). Improving the communication function of published accounting statements. Accounting and Business Research, 14(54), 139-146.