The working ratio is a measure of the ability of a business to recover its ongoing operating expenses. It is used as a general indicator of the financial health of a business, though it yields a figure that is imprecise.
Annual operating expenses - Depreciation expense
Annual gross revenue
If the ratio is less than 1, it implies that the business is capable of at least recovering its operating expenses. A ratio of greater than 1 indicates that the company cannot be profitable.
The working ratio is not one of the more reliable performance measures, for the following reasons:
- It does not include financing costs
- It assumes that a ratio of 1 is good, when in reality, that is (at best) zero profitability
- The denominator should use net revenue, rather than gross revenue, thereby including the impact of sales returns and allowances.
- It does not account for projected changes in operating expenses.
- It assumes that cash flows exactly equate to the amounts of operating expenses and gross revenues stated in the formula, which may not be the case.
In short, the working ratio is excessively imprecise, and so is not recommended as a method for evaluating the financial condition of a business.