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The efficiency ratio compares a company’s operating expenses to its revenue to measure cost efficiency. It is a key indicator of operational effectiveness, particularly in financial institutions. A lower ratio generally signifies more efficient resource utilisation and profitability.
The efficiency ratio evaluates how efficiently a company converts its inputs (like expenses or assets) into outputs (such as revenue or profit).
It’s most commonly used in banking, finance, and business analysis to assess cost efficiency and operational performance.
In general, a lower efficiency ratio implies higher operational efficiency — meaning the company spends less to earn more.
Example (Banking Context):
In banks, the efficiency ratio shows how much it costs to generate one dollar of revenue.
If a bank has an efficiency ratio of 60%, it means it spends ₹0.60 to earn ₹1 in revenue.
At its core, the efficiency ratio compares operating expenses to net revenue, showing how well management controls costs relative to income.
Efficiency Ratio = (Operating Expenses ÷ Net Revenue) × 100
Operating Expenses include employee salaries, rent, utilities, and administrative costs.
Net Revenue is total revenue minus interest expense or cost of goods sold (depending on context).
A lower ratio indicates higher efficiency — meaning the firm is controlling costs effectively and earning more per unit of expense.
The formula for efficiency ratio can vary by industry, but the principle remains the same — it compares expenses to revenues or outputs.
Efficiency Ratio = (Operating Expenses ÷ Operating Revenue) × 100
| Particulars | Amount (₹) |
|---|---|
Operating Expenses |
600 crore |
Operating Revenue |
1,000 crore |
Efficiency Ratio |
(600 ÷ 1,000) × 100 = 60% |
Interpretation:
A 60% efficiency ratio means that 60% of revenue is consumed by operating expenses. Generally:
Below 60% → Indicative of strong efficiency
60–70% → Moderate efficiency
Above 70% → Relatively higher cost ratio
Manufacturers may calculate an efficiency ratio based on asset utilization, such as:
Efficiency Ratio = (Revenue ÷ Total Assets)
This measures how effectively the company uses its assets to generate sales.
Here’s how efficiency ratios are applied across different industries to measure performance:
Used to measure cost control relative to income.
A bank with an efficiency ratio of 55% is more efficient than one with 70%, as it spends less to generate each unit of revenue.
Can reflect production efficiency, where lower ratios mean less resource waste and higher throughput.
Used to assess how efficiently service providers (like IT firms) convert employee hours and costs into billable revenue.
May link store operating costs to sales, helping gauge outlet-level efficiency.
Here are the key advantages of using the efficiency ratio for performance evaluation:
Evaluates Cost Efficiency:
Highlights how well a company manages its operational costs relative to income.
Supports Benchmarking:
Enables comparison across companies or time periods to track efficiency improvements.
Improves Decision-Making:
Guides management in cost control, productivity improvements, and resource allocation.
Provides insight for investors:
A consistently low efficiency ratio signals strong operational discipline and profitability potential.
Indicates potential profitability trends:
Companies with efficient operations typically deliver more stable and higher margins.
While useful, the efficiency ratio has certain limitations:
Industry Variance: Accepted ratios differ across industries — what’s efficient for a manufacturer may not suit a bank.
Ignores Quality: Focuses purely on cost and revenue, not product or service quality.
May Exclude Non-Operating Items: Doesn’t always reflect total company expenses.
Affected by Accounting Choices: Different accounting methods can distort comparisons.
Short-Term Focus: High short-term efficiency might sacrifice long-term sustainability (e.g., cutting R&D).
Hence, analysts often use it alongside profitability and leverage ratios for a fuller financial view.
The efficiency ratio highlights how well a company utilises its resources to generate revenue. It offers a clear view of operational effectiveness and cost discipline over time.
The efficiency ratio reveals how effectively a firm converts expenses into revenue.
A lower ratio indicates stronger cost control and operational efficiency.
Widely used across industries — especially in banking, manufacturing, and services.
Should be compared over time and with industry peers to assess trends.
Balanced efficiency ensures cost control without compromising growth or quality.
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
The efficiency ratio is a financial metric that measures how effectively a company manages its operating expenses relative to its revenue. It helps assess cost control and operational productivity — the lower the ratio, the more efficiently a company is operating.
Common types of efficiency ratios include:
Asset Turnover Ratio – evaluates how efficiently a company uses assets to generate revenue.
Inventory Turnover Ratio – measures how quickly inventory is sold and replaced.
Receivables Turnover Ratio – assesses how efficiently a business collects customer payments.
Payables Turnover Ratio – indicates how effectively a company manages its supplier payments.
Each ratio focuses on a specific area of operational efficiency.
The efficiency ratio is generally calculated quarterly or annually, depending on the organisation’s reporting cycle and data availability. Regular analysis helps track trends and identify potential areas for cost improvement.
In the banking industry, the Efficiency Ratio = Operating Expenses ÷ Net Revenue is commonly used. It measures how much of a bank’s income is consumed by operating costs, serving as a key indicator of cost management efficiency.
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