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Overhead Ratio Formula | Examples | How to Calculate Overhead Ratio? - YouTube
Channel: WallStreetMojo
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hello everyone hi welcome to the channel
of WallStreetmojo watch the video
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till the end also if you are new to this
channel then you can subscribe us by
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clicking the bell ican friends today we're
going to learn a concept which is known
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as the overhead ratio formula now over
it is always been a burden on any
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company because the cost will eat up
their profits so who likes their the
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profits to be eaten up by high or /
increasing overhead in the company let's
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understand this formula and we'll have a
deep insight regarding all the aspects
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that we need to consider in this
particular formula the overhead ratio
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formula is basically or all the
operating expenses that you have divided
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by the operating income plus the taxable
net interest income okay no issues you
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must have got a however here to worry
we'll get into the utility of the same
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the overhead ratio formula let me write
for you overhead ratio formula is
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specifically this this this ratio is
specifically used by the banks in in
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general yes absolutely
well here we take the operating expense
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into the into account the operating
expense into account then and compare
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the expenses with the total income that
cannot be attributed directly to the
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production of the goods and goods or
service in total let's see the formula
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let's jot down a formula over here for
us over at ratio formula is basically
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our operating income divided by the
sorry this is the operating expense over
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here and we'll have to write below that
the operating income plus the taxable
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net interest income now for this formula
alternatively many argue you know that
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the over it can be expressed as the
proportion
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I mean know between the operating
expense and the revenue however the
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proportion is called basically the
operating expense ratio so and not an
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overhead ratio they don't call it in as
as the overhead ratio so the overhead
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ratio example that we are going to
consider to understand this particular
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formula in really detail one let's take
an simple example to calculate the
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overhead cost let's say there is a
company called kg Inc and it has some
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following information which are as
follow they have the detail of operating
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income or the operating expense which is
standing at let's say 23,000 then the
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then they have the operating income
which is standing at $1,15,000
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and the another one is
the taxable net interest income which is
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standing at let's say $46,000 so these are a couple of numbers
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that we have jotted down and we need to
find out the ratio of kg Inc and let's
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let's see we know that you know both the
numerator and the denominator of the
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ratio the operating expense which is
standing at 23,000 the denominator would
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be the sum of the total operating income
in the taxable net interest income so
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using the overhead formula we get some
numbers as follow we'll try and put down
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the numbers in this particular formula
itself so that is equal to the operating
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expense over here and in in here we we
need to put things in bracket the
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operating income plus the taxable net
interest income
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we have jotted down all the numbers
finally what we have in our answer is AZ
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is equal to 23,000 divided by 1,61,000 so we have 14%
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14% or 14.29 or
14.30 as and
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answer so we we inputted a data in our
formula but we need to interpret this so
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to interpret the ratio of KG Inc we
need to look at the ratios of the
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other restaurants who are in the similar
food and providing the similar services
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then and then only you'll be able to
make a comparison it's called the comm
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company based perishing right let's
understand the explanation part of this
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particular formula see in this ratio we
have to consider two component the first
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the first component over here is the
operating alright the first component is
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the operating expenses right so
operating expenses are like you know the
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day-to-day expenses if any that the
company needs to run for the business
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right for the for example I mean the
utilities the machinery maintenance
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officer and professional fees insurance
etc the operating expenses the
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second the second most important part of the component of the overhead ratio is a
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little bit a tricky one we'll take the
operating income over here and also the
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taxable net income the taxable net
interest income right so these are the
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two common components see when we deduct the operating expenses from the gross
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profit less the operating expenses we
get the operating income isn't it quite
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clear this is how we find so to get an
in the second to get the net interest
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income we need to look at the difference
between how much a company interest
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received basically how much the company receives the interest less how much
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interest it pays right so the net
interest income is the common measure
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for banks which we discussed at the very
inception in but we can calculate the
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same for the companies also so we'll de
da will will add the operating income
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and the taxable and interest income to
get basically the denominator side
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now let's understand the use of this
particular formula what is the use see
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overhead formula is a significant
measure for a company for any company
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because if it is lower but better would
be the performance but the performance
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of the company on the other hand if it
this ratio is higher the company isn't
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utilizing its a resource
prudently I would say the resources are
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not utilized prudently right every
company every company should try to
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lower down the ratio as much as it can
see there are two portion of the
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operating expense that a company can
look at the first component of the
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operating expense is the expense that
can be curved so try and reduce the
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expenses as much as possible in this
case the company should try to reduce
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the component this component as much as
they can because that is going to be a
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hedge against the second component the
second component of the operating
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expense can be removed completely I mean
the company should take steps to pare
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down the second component and to reduce
this particular ratio however you know
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reducing this the ratio shouldn't be
shouldn't affect the company's
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performance I mean too much reduction in
this in this ready in this ratio in the
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operating expense may affect the
company's company negatively the company
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should try to maintain a balance and
and reduce only that much which does not
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reduce the efficiency of the company now
this is of a calculator you know we can
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put down some numbers and really come up
with some good results out of the same
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let's say we take our operating expense
as $50,000 the operating income which is
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standing at let's say 1 lakh dollars and
the total net interest income let's say
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it is standing at $10,000 so the
overhead ratio formula is 25%
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so 50,000 divided by 1,10 then
now keeping this as constant if you
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increase this to 60,000 your ratio is
going to increase and higher the ratio
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is not good so what you need to do is
that you need to reduce this to make
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your ratio to fall down to 15% so this
is how we can put down some good numbers
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and come up with some really good
results so that's it for this particular
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topic if you have learned and enjoyed
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