Is the Expense Ratio a Useful Measure?

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The expense ratio is used to gauge the relative magnitude of expenses in comparison with revenue. It is computed by dividing the total operating expense by total revenue.

Many companies benchmark their expense ratio against an industry average. My view is that it is not a very useful comparison because your business and operations could be very different from others.

To make sound business decisions about expenses, you need to evaluate expenses at a more granular level. Breakdown the expenses and revenues by line of business, service category, or customer segment. The details will provide more useful insights about issues such as staffing level, productivity, or pricing for that particular service or customer segment you serve.

Without doing so, you are generalizing that all customers and revenues are the same. They aren’t the same and therefore, you need to look them separately.

The expense ratio is more meaningful when you segregate the revenue streams and their corresponding expenses and do the evaluation accordingly.

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