KPI of the Day – Accounting: # Berry ratio
Definition
Measures the ratio of an organization’s gross profits to operating expenses.
Purpose
To assess the organization’s profitability.
Recommendations
Although the # Berry ratio is a simple profitability measure, it is probably one of the most misused ratios in the context of transfer pricing analysis. Interpretation errors may appear if analysts do not understand this indicator’s limitations. The Berry ratio cannot be applied to distributors that also perform manufacturing functions, as it cannot capture the additional return earned by the manufacturing function.
Empirical studies have shown that distributors with low operating expense intensity (less than 10%-15% relative to sales ratios) show very high Berry ratios when compared with distributors with higher operating expenses. Therefore, extra caution should be taken when comparing two distributors with very different operating expenses.
The selection of the adequate Profit Level Indicators (PLI) to measure a company’s return on investment commonly requires a thorough analysis. For the # Berry ratio to become a reliable Profit Level Indicator it should be applied when several conditions are met:
- A valid link between the $ Operating expenses and the $ Gross profit is identified;
- The measurement of the KPI is performed when no intangible assets are employed;
- Inventories and cost of sales are divested from company funds;
- $ Operating expenses are the only expenses yielded by the enterprise.
Under these circumstances, it is recommended that the # Berry ratio is mostly used with low-risk procurement and distribution service providers which have no funds blocked in inventories and employ no intangible assets.
The # Berry ratio is also frequently referenced for the Transactional Net Margin Method. The Transactional Net Margin Method or TNMM examines the net profit margin relative to costs, assets, or sales. The selection of the # Berry ratio for this particular method, should, however, be based on a rigorous analysis focusing on the criteria of risk and value drivers.
Furthermore, given the universality of the measure, it suits benchmarking very well. Targets may vary based on industry profile. A ratio of 1 or more indicates that the company is making a profit above all operating expenses, whereas a ratio below 1 indicates that the firm is losing money.
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Tags: Accounting KPIs, KPI
