Operating Expense Ratio (OER)
What it is:
How it works (Example):
The formula for OER is:
Let's assume Company XYZ's operating expenses in 2008 were $2,000,000 and its revenues were $10,000,000. Using the formula above, we can calculate that Company XYZ's OER is:
OER = $2,000,000 / $10,000,000 = 20%
If Company XYZ were a real estate company, it might calculate the OER on a potential property similarly. Let's assume it could rent a property to tenants for $100,000 a month but would have to pay $35,000 a month in utilities, maintenance, insurance, and upkeep. In that case:
OER = $35,000 / $100,000 = 35% per month
Why it Matters:
Operating expenses are costs associated with running a business's core operations on a daily basis. Thus, the lower a company's operating expenses are, the more profitable it generally is. Over time, changes in the OER indicate whether the company can increase sales without increasing operating expenses proportionately (i.e., if the business is scalable). In real estate, companies can compare properties by using the ratio.
As such, the OER is also a measure of managerial flexibility and competency that makes companies easier to compare. However, it is important to note that some industries have higher OERs than others. This is why comparing OERs is generally most meaningful among companies within the same industry, and the definition of "high" or "low" expenses should be made within this context.