In accounting, the cost-to-income ratio measures the cost of running a business compared to its operating income. The lower the cost-to-income ratio is, the more profitable the company should be. It's a useful metric for gauging the efficiency of the operation.
Calculating the Cost-to-Income Ratio
To obtain the cost-to-income ratio, simply divide the organization's operating expenses by its operating income for the same period. Operating expenses in this context comprise all the costs of running the business such as fixed costs (rent, mortgage, insurance, utilities, property taxes and so on) and administrative expenses (salaries, stationery and marketing costs). Revenue includes sales receipts, fee income and interest earned on loans.
Example of Cost-to-Income Ratio
Say that Acme Corporation has $150,000 of operating expenses in June. It also has an operating income of $275,000. To find the cost-to-income ratio, divide Acme's operating expenses by its operating income. In this example, $150,000 divided by $275,000 gives a cost-to-income ratio of 0.545. The company will usually express this as a percentage, being a 54.5 percent cost-to-income ratio.
Why It Matters
A cost-to-income ratio of 54.5 percent means that Acme Corporation is spending $0.54 to generate $1 of revenue. So, you can see at a glance how efficiently a company is being run. A low cost-to-income ratio means the company is managing its costs well and is not overspending to generate revenue. A high cost-to-income ratio, on the other hand, suggests that a company is not being as efficient as it might be in controlling costs. What constitutes a high or low cost-to-income percentage depends on the business and the industry. In most industries, 50 percent is the maximum acceptable ratio.
Watch Out for Cost-to-Income Ratio Changes
Changes in the cost-to-income ratio can indicate problems for the business. If the ratio rises – either sharply or gradually across multiple accounting periods – it suggests that costs are increasing at a faster rate than income. Either the expenses are spiraling upward, or the revenues are dropping. As a result, the company is having to spend more money than before to earn the same amount of income, a signal for management to step in and bring costs under control or develop strategies for attracting more business.
Who Uses the Cost-to-Income Ratio
The cost-to-income ratio is a critical financial metric for any business, but it's a particular feature of the financial sector. Banks and financial institutions often use the ratio to track how costs are changing compared to income so they can make strategic growth decisions. For example, investing in customer service might immediately lower a bank's cost-to-income ratio but improve its overall profit. The idea is to use the cost-to-income ratio as a jumping- off point for creating additional revenue streams that have a relatively low cost associated with them, such as selling other services to existing customers, so income rises faster than expenses.
Jayne Thompson earned an LL.B. in Law and Business Administration from the University of Birmingham and an LL.M. in International Law from the University of East London. She practiced in various “Big Law” firms before launching a career as a business writer. Her articles have appeared on numerous business sites including Typefinder, Women in Business, Startwire and Indeed.com.