Question

1. what items in the income statement explain he change in income from continuing operations as a percentage of revenue

2. what are possible explanation for changes in the percentage of operating costs

Answer 1

Part 1

Answer is Operating Margin Ratio.

Explanation: This ratio measures the efficiency with which each and every dollar of a company is being used to generate revenue from current operations. In other words, it measures the amount of operating profit a company is able to generate on every dollar of sales. By operating profit, it is intended that the same is before providing for interest expense or tax. Operating profit is also known as EBIT (Earnings before Interest and tax)

Formula: Operating Margin Ratio = Operating Profit / Revenue

A high operating ratio works as a cushion to investors, especially lenders, as this is the profit available for interest payments and dividends payments (after tax, can be retained though to increase overall company value).

Year on year comparison of operating ratio suggests the increasing or decreasing efficiency of company.

Other side of Operating Margin Ratio is Operating Expense Ratio. As the name suggests, it compares operating costs to the revenue of the company (Formula: Operation Costs / Revenue). As seems correct, lower operating expense ratio is better. Operating Margin Ratio and Operating Expense Ratio behave opposite to each other.

Part 2

Percentage of Operating Cost (also known as variable cost) is subject to change due to various reasons, some of which are:

• Change in raw material cost
• Change in labour cost
• Change in Fuel or Power cost, etc.

These costs are directly linked to the level of revenue. Percentage increase or decrease means that operating expense per unit of sales are increasing or decreasing, impacting directly the profitability of company.