Railway Accounts Department Examinations

Showing posts with label profit centre. Show all posts
Showing posts with label profit centre. Show all posts

Friday, May 8, 2020

O.R. - Operating Ratio in Indian Railways

O.R.  -  Operating Ratio in Indian Railways

Likely Questions:

1. What is Operating Ratio ? How it is calculated ?

2.  Computation of the Operating Ratio from the set of figures given in the problem.

3.Is OR, best financial ratio to show the performance of Railways ? If answer is No, what is the reason and which one is the alternative one ?

4. Can we extends the O.R to the Divisions in replacement of PEI (Performance Efficiency Index) ? If so what is the mechanism and the benefits accrue to Railways ?

1. What is Operating Ratio ? How it is calculated ?

ü  Codal provisions - Para 308 & 434 of I.Rly.Finance Code.

ü  It is regarded as one of the Most Important financial statistics/ratios and has frequently been used as an Index of the operating efficiency of the Railways.

ü  Definition of O.R.: Percentage of Gross Working Expenses to Gross Earnings of any accounting year. In general, Operating ratio is the number of rupees spent to earn every 100 Rupees.

ü  If O.R.  is less than 100 = Organisation is in profits.

ü  If O.R. is more than 100 =  Organisation is in losses.

ü  Definition of Gross Working Expenses (GWE):  Ordinary Working Expenses-OWE (Demands 3 to 13) plus Appropriations to DRF-Depreciation Reserve Fund and Pension Fund.  Note: True expenses in an accounting period whether or not actually disbursed.  That means excludes Suspense.

ü  Definition of Gross Earnings: Coaching Earnings (Abstract X) + Goods Earnings (Abstract Y) + Sundry other Earnings (Abstract Z)  Note: true or accrued earnings in an accounting period whether or not actually realised. That means excludes  Suspense.

ü   Always considered Apportioned Earnings instead of Originating Earnings.

Gross Working Expenses

ü  O.R  =     _______________________    x  100

Gross Earnings

ü  Important Note:

ü  Gross Expenditure (Working Expenses actually disbursed during an accounting period)  = Gross Working Expenses + Suspense

ü  Gross Receipts (Earnings actually realised during an accounting period)

= Gross Earnings + Suspense.

ü  That means :-

Gross Receipts  - Always includes Suspense

Gross Earnings - Always excludes Suspense.  It is denominator for O.R. formulae.

Similarly

Gross expenditure -  includes Suspense.

Gross Working Expenses -excludes Suspense.  It is numerator for O.R. formulae.

ü  In the examinations, if Gross Expenditure figure given, deduct Suspense from that in order to arrive Gross Working Expenses.  Similarly deduct Suspense from Gross Receipts to arrive Gross Earnings.

ü  Assumption is Suspense on Expenditure side is Debit balance i.e., plus figure and Suspense on Earnings side is Credit balance i.e., plus figure.

ü  In case of confusion, what you presume is clearly spelt out at the end of solution in the Examination. (by way of Notes).  In that case, examiner will award marks in spite of incorrect answer.  Because Examiner will take into consideration whether you understand and expressed the concept or not.

ü  There is no ideal Operating Ratio for Indian Railways.  In rail road sector, an operating ratio of 80 or lower is considered desirable. However lower O.R. helps in generating internal resources for meeting requirement of Plan Expenditure on Safety (RSF), Amenities to Passengers & Staff (D.F) and other Capital investments such as laying of new lines, acquisition of Rolling Stock etc (Capital Fund).

ü  In the year 2005, Indian Railways, changed its accounting policy for the lease charges. The lease charges have been broken into two parts - capital and revenue. While revenue has been charged to working expenses (Demand No.9G), capital portion is separately provided for in the capital budget ( Plan Head 2200-Leased assets -  Payment of  capital component of lease charges to IRFC etc.). This has resulted in the reduction of working expenses and the operating ratio.

ü  Measures to be taken to achieve the Lower/efficient O.R. are

A) maximizing the traffic earnings inter-alia include rationalization of fare and freight tariff; effective marketing strategies to capture more and more traffic; creation of additional capacity and optimum utilization of the existing rail infrastructure.

B) contain the expenditure through diverse means including strict economy and austerity measures; improved man-power planning; better asset utilization and inventory management; optimizing the fuel consumption etc.

ü  The Best ever O.R of Indian Railways was 74.7 % in 1963-64.

ü  Last  few years O.R. of Indian Railways is

2009-10  -  94.7 %

2010-11  -  92.3 %

2011-12  -  94.9 %

2012-13  -  88.8 % (against the target of 84.9%)

ü  Target O.R of 2013-14  -  87.8 %

ü  Target O.R of 2016-17  -  74 %

ü  2016-17 i.e., terminal year of 12th Five Year Plan (2012-17) target O.R. is 74 % ( to equal the best ever O.R. of Indian Railways in 1963-64 - 74.7 %)

ü  Comparing O.R of Indian Railways with other countries ' railways systems  - Not possible due to different computation methodologies across different countries thus reducing validity of comparison of such statistical figures.

Glossary - Excerpts from Finance Code Para No.308 -  better to understand Operating Ratio and Railway finances.

 Credit Side Debit Side Net of Credit & Debit (i) Coaching Earnings (less refunds) (x) Ordinary Working Expenses = Expenses booked under final heads, excluding appropriation to DRF & Pension Fund (ii) Goods Earnings (less refunds) (xi) Appropriation to Depreciation Reserve Fund. (iii) Traffic Earnings = (i)+(ii) (xii) Appropriation to Pension Fund. (iv) Sundry Other Earnings (less refunds)=Other than Traffic Earnings. (v) Gross Earnings = (iii)+(iv) = true or accrued earnings in an accounting period whether or not actually realized. (xiii) Gross Working Expenses = (x)+(xi)+(xii) = True expenses in an accounting period whether or not actually disbursed. (xviii)  Net Earnings =(v) - (xiii)           O.R = (Xiii) /(v) x 100 (vi) Suspense. (xiv) Suspense. (vii) Gross Receipts = (v)+(vi) = Earnings actually realized during an accounting period. (xv) Gross Expenditure = (xiii) + (xiv) = Working Expenses actually disbursed during an accounting period. (viii)Misc. Receipts = Guarantee recoverable from State Govts. + Other Misc. Receipts, such as Govt. share of surplus profits, sale of  land of subsidized companies, receipts from surcharge on Passenger fares, etc. (xvi) Misc. expenditure = Surveys + Land for subsidized companies; subsidy + other Miscc Railway expenditure, Appropriations to Pension Fund relating to Railway Board and Miscc establishments booked under grants 1 & 2 and Accident Compensation, Safety and Passenger Amenities Fund and OLWR expenditure, and payments to worked lines. (ix) Total Revenue Receipts = (vii)+(viii). (xvii) Total Revenue Expenditure = (xv)+(xvi). (xix) Net Receipts =  (ix) - (xvii).

 (xix) Net Receipts = (ix) - (xvii). (xx) Payment to General Revenues (Dividend) (xxi) Surplus =  (xix) - (xx)   (shortfall if the figure is negative)

Appropriation of Surplus:  The surplus will be appropriated to Development Fund, Railway Safety Fund, Capital Fund and latest created fund " Railway Liability Reserve Fund.

ü  Comparing O.R of different Zonal Railways:  It is not possible to compare the O R of one Zonal Railway with another Zonal Railway due to several factors such as Floods, Accidents and other special factors.  Hence it is better to compare OR of particular Zonal Rly from Year - Over - Year (YOY) basis.

In simple terms , the Operating Ratio is calculated based on the following glossary terms only

 Denominator Numerator (Gross Working Expenses) 1.Gross Earnings 1.OWE - Ordinary Working Expenses i.e., 3 to 13 Demands 2. Appropriation to DRF & Pension Fund i.e., D.No.14

Formulae of OR = Gross Working Expenses \ Gross Earnings x 100

Forget the following Glossary terms of calculation of O.R.

 Never taken the following items for calculation of Operating Ratio Earnings Side Expenditure side Suspense Suspense Gross Receipts Gross Expenditure Misc. Receipts Misc. Expenditure Dividends paid to Gen. Revenues Appropriation to D.F, Safety Fund, Capital Fund

Note: Where ever, Gross Receipts and Suspense (Earnings) were given, simply deduct suspense from Gross Receipts and arrived Gross Earnings (Denominator) for calculation of Operating Ratio

Similar lines,

Where ever, Gross Expenditure and Suspense (Expenses) were given, simply deduct suspense from Gross Expenditure and arrived Gross Working Expenses (Numerator) for calculation of Operating Ratio.

So, Golden Rule is Suspense on either side will not be taken for calculation of Operating Ratio.

2. Working out the following from the set of figures as given below.

i) Operating Ratio  ii) Net Receipts  iii ) Surplus/Shortfall

 Details Amount(In Crores of Rs.) 1. Gross Receipts 1400 2. Suspense - Earnings 150 3. Misc. Receipts 50 4. Expenditure (Actual basis) 800 5. Suspense - expenses (- ) 50 6. Appropriation to DRF 65 7.Appropriation to Pension Fund 85 8. Misc. Expenditure 25 9.Dividends payable 75 10. Appropriation to D.F. 150 11. Appropriation to R.S.F. 100 12. Appropriation to Capital Fund 150

Solution:

i) Operating Ratio

Formulae of  OR  =  Gross Working Expenses / Gross Earnings x 100

Gross Earnings = Gross Receipts minus Suspense

Hence  1400 -  150 = 1250 is Gross Earnings.

Gross Working Expenses = Ordinary Working Expenses(OWE) + App. to DRF & P.F

Ordinary Working Expenses ( OWE)  =  Actual Expenditure  minus  Suspense

=  800  -  (-) 50 = 850  (Note: Minus of Minus = Plus)

Gross Working Expenses = OWE + App. to DRF & Pension Fund.

Gross Working Expenses  =  850 + 65 + 85 = 1000

Hence O.R . =  1000 / 1250 x 100 = 80 %

ii) Net Revenue

Net Revenue = Total Revenue Receipts - Total Revenue Expenditure

Total Revenue Receipts = Gross Receipts + Misc Receipts.

= 1400 + 50 = 1450

Total Revenue Expenditure = Gross Expenditure + Misc. Expenditure

Gross Expenditure =  800 + 65 + 85 = 950 and Misc. Expenditure  = 25

Total Revenue Expenditure   =   950 + 25  = 975

Net Revenue = Total Revenue Receipts - Total Revenue Expenditure

Net Revenue = 1450 - 975  =  475

iii) Surplus/Shortfall

Surplus  =  Net Revenue - Dividends Payable

=  475  -  75  =  400

Surplus  =  400

Note: Appropriation to Development Fund, Railway Safety Fund & Capital Fund will not be considered for calculation of Operating Ratio/Net Revenue/Surplus.

3. Is OR, best financial ratio to show the performance of Railways ? If answer is No, what is the reason and which one is the alternative one ?

ü  It is true, that the Operating Ratio itself is not a perfect indicator for judging the efficiency of Indian Railways.

ü  Let's see the below hypothetical illustration of two Railways.

 Rly. Capital at Charge Gross Earnings Gross Working expenses O.R. ROR- Rate of Return/ROCE-Return on Capital Employed A 1000 200 150 75 % 5 % i.e., Rs.50 profit on Capital of Rs.1000 B 5000 2000 1600 80 % 8 % i.e., Rs.400 profit on Capital of Rs. 5000

ü  Considering the Operating Ratio as efficient indicator, Railway "A" is more efficient than Railway "B".  But taking ROR/ROCE i.e.,  indicator of utilisation of Capital, Railway "B" is more efficient than Railway "A".

ü  If so, as mentioned in Para 511 of Indian Railways Administration and Finance - An Introduction, Return on Capital i.e., percentage of (revenue) surplus to  Capital-at-charge is the true indicator to judge the financial performance of Indian Railways.

ü  Revenue Surplus = Net Receipts (actual basis) after adjusting misc receipts and misc expenditure and payment of Dividend to General Revenues. (item xxi of para 308-Finance Code)

ü  Capital at Charge means "the Central Government's investment in the Railways by way of Loan Capital and value of the assets created there from. (item xxii  of para 308-Finance Code)

ü  To sum up, the combination of above two Ratios will be considered to evaluate the performance of the Railways instead of Operating Ratio alone.

ü  Operating Ratio is helpful for comparing the Railways' efficiency of Year-over-year(YOY) as well as evaluating the Inter Zonal comparison among different  Zonal Railways in India.

4. Can we extends the O.R to the Divisions in replacement of PEI (Performance Efficiency Index) ? If so what is the mechanism and the benefits accrue to Railways ?

DIVISIONS and PEI - Performance Efficiency Index

ü  At present, PEI is the performance indicator in the Divisions ( like OR-Operating Ratio for Zonal railways)

ü  As of today, OR is not being calculated for Divisions and thus they cannot be treated as “Profit Centers”.

ü  PEI =  a ratio of Demands  3 to 12 and  Originating Earnings .

ü  That means unlike Operating Ratio, Appropriation to DRF and Pension Fund will not be considered for calculating PEI.  Also Apportioned Earnings not considered for calculating PEI.

Demands 3 to 12

ü  PEI of Division =     _______________________    x  100

Originating Earnings

 Differences between Operating Ratio - O R Performance Efficiency Index - PEI 1. D.No. 3 to 13 considered 1. D.No. 3 to 12 only considered. 2. Taken into the Apportioned Earnings 2. Taken into the Originating Earnings. 3. Appropriation to DRF & Pension Fund are considered. 4. Not taken into the account of appropriation to DRF & Pension Fund.

Note: In some Zonal Railways like SCR, D.No.13 also included for calculating PEI.

So, the drawbacks and their solutions for computing Operating Ratio of their respective Divisions are

1. Appropriation to DRF -

 Appropriation to DRF from the Division can be computed as:     Capital at Charge on the Division / Capital at Charge on the Zone  x Appropriation to DRF for the Zone. 2. Appropriation to Pension Fund -  It would be possible to calculate the Appropriation to Pension Fund from the Division based on the     Pensionable employees on Division /Pensionable employees on the Zone  x Appropriation to Pension Fund.

3. Apportioned Earnings  - Right now, based on the proportionate distance of consignment or passenger travelled over the Zonal Railways, the apportioned earnings can be calculated for the Zonal Railways. The same mechanism will apply for calculate of apportioned earnings for the Divisions based on distances covered among Divisions within a Zonal Railway.  With the help of Computers, it can be very easy exercise.

• If we address the above drawbacks in correct approach as stated above, Divisions also can able compute Operating Ratio (OR) and became Profit Centers similar to Zonal Railways.  Because,

" What cannot be measured, cannot be managed"  By  Peter Drucker/ Deming

"If you cannot measure it, you can’t improve it"  By  Lord Kelvin

Note:

I express special thanks to Shri Hemant B.Godbole, SAG/IRAS of kind permission for using the excerpts from his presentation of "Application of Responsibility Centre Approach for converting Divisions into Profit Centres" .

Click below for full presentation of Shri Hemant B. Godbole, SAG/IRAS

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