Operational Efficiency

Reviewed by Bhavana | Updated on Aug 27, 2020

Introduction

Operational efficiency is primarily a measure of profit efficiency earned as a function of operating costs. The greater the efficiency of operations, the more profitable it is for a company or investment. This is because the entity can generate higher income or returns for the same or lower cost compared to an alternative. Operational efficiency occurs in financial markets when transaction costs and fees are lowered.

Operational performance is a calculation of the costs incurred during a particular economic or financial activity, such that the lower the costs are, greater the efficiency.

One way to elevate the operational efficiency of financial markets is to give bulk discounts or free commissions to traders. Investment market operating efficiency is typically centred around investment-related transaction costs. Investment market operating efficiency can be compared with general business practices for production operating efficiency.

Understanding Operational Efficiency

Operational efficiency and markets that are operationally efficient can help improve the overall effectiveness of investment portfolios. Greater operational efficiency in investment markets means that capital can be allocated without the high cost of friction, which reduces a portfolios risk/reward profile.

An extensive operating performance also analyzes investment funds. One metric for assessing operational efficiency is the cost ratio of a company. A number of factors impact a fund's spending ratio transaction costs, management fees, and administrative costs. Comparatively, it is generally considered that funds with a lower expense ratio are more operationally efficient.

Due to a higher number of shares transacted per transaction, funds with higher assets under management will achieve greater operational efficiency.

By index replication, passive funds offer targeted market exposure. Large funds have the advantage of selling economies of scale. With passive funds, lower transaction costs are also incurred after an index holding.