Working Ratio

The working ratio measures a company’s ability to recover its operating costs from annual revenue. It focuses on operating performance by excluding non-operating items such as depreciation and debt-related expenses.

Formula

Working Ratio = (Total Annual Expenses − (Depreciation + Debt Expenses)) / Annual Gross Income

A lower working ratio indicates that a smaller portion of gross income is consumed by operating costs. A ratio below 1 means the company generates enough revenue to cover its operating expenses; a ratio above 1 means it does not.

Key takeaways

• Shows how effectively revenue covers operating costs (excluding depreciation and financing).
• Ratio < 1: operating income covers expenses.
• Ratio > 1: operating expenses exceed operating revenue.
• Useful for comparing operational efficiency across periods or peers in the same industry.

How it’s used

The working ratio helps assess whether a company’s core operations are sustainable without relying on non-operating income or one-time gains. Analysts track the ratio over time to spot trends (improving or worsening operational efficiency) and compare it to industry benchmarks.

Example

XYZ Inc. uses outdated, energy-intensive machinery that costs more to operate and maintain than modern alternatives. Sales are falling as competitors gain market share. As costs rise and revenues fall, XYZ’s working ratio climbs above 1, signaling that its operations no longer generate enough revenue to cover operating expenses—indicating a need for cost reduction or investment in more efficient equipment.

Limitations

• Excludes financing costs: ignoring interest and principal repayments can understate total cash obligations.
• Ignores depreciation’s economic impact: while depreciation is non-cash, it reflects asset wear and replacement needs.
• Sensitive to one-time or seasonal swings in operating costs or revenues, which can distort a single-year ratio.
• Doesn’t reflect cash reserves or expected future revenues that might temporarily justify a higher ratio.

Practical advice

• Use the working ratio alongside other metrics (gross margin, operating margin, leverage ratios, cash flow) for a fuller picture.
• Compare ratios within the same industry, since operating structures vary widely.
• Look at multi-year trends rather than a single period to distinguish temporary fluctuations from persistent problems.
• Investigate causes of unusual results—cost spikes, asset write-offs, or temporary revenue dips—before drawing conclusions.

The working ratio is a straightforward indicator of operating performance but should be interpreted in context and combined with other financial measures for investment or management decisions.