Return On Net Operating Assets

(Definition, Formula, Examples and Calculations)

 

What is an operating asset?

Operating assets are the assets required by the business to execute business operations and generate revenue. Examples of operating assets include prepaid expenses, fixed assets, inventories, cash, and accounts receivables, etc. Further, intangible assets like patents, technology, and licenses are also considered operating assets if used to manufacture and generate revenue.

However, financial assets like marketable securities are not considered operating assets as these do not help the business to perform principal business activities and generate revenue.

What is operating liability?

Operating liabilities arise as a result of the business operations. The amount payable to other businesses or individuals remains outstanding and the related expenses incurred for business-related operations.

Net operating asset

Return on net operating asset – (RNOA)

Return on net operating asset aims to measure return generated by the business operations. It’s an important analytical tool to measure the efficiency of the business in terms of net asset utilization.

Generally, a higher value of RNOA is desirable as it suggests that the business has utilized its assets efficiently and controlled expenses. On the other hand, the lower value of RNOA suggests that a business needs to improve its profitability; it can be done by increasing the efficiency of the assets and control of expenses.

Explanation of the RNOA

The business can generate profit via two types of activities. These activities include operating activities and financing activities. The operating activities can be different for the different businesses. A few examples of the industrial sectors and operational activities are given below.

Industrial sector Operational activities
Manufacturing Production and sale of the goods
Trading Purchase and sale of the goods
Leasing Earnings of the lease rentals
Insurance Earning insurance premium against covered risk
Marketing Earning revenue via marketing products and services

 

Further, it is important to note that investors are more interested in the operating income or performance of the operating assets.

Formula

Following is the formula to calculate return on net operating assets.

Return on net operating assets = Net profit/Net assets

The result of these calculations is in percentage, which means metrics can be compared with other companies in the same industry sector. Further, this ratio helps assess return on daily operations and indicates if the business can directly control business/operational activities. Likewise, a higher value of RNOA is mode desirable.

Advantages of Return on net operating assets

Following are some of the advantages of calculating return on net operating assets.

  1. It helps investors to understand if the business management is using assets at their full potential. In other words, it gives investors an idea if the business is operating at its full potential.
  2. This matric is represented in percentage terms, and it means it’s easy to compare this performance matric with other companies and asses comparative performance.
  3. It’s difficult to manipulate this ratio because it can be hard to change net profit and operating assets figures.

Disadvantages of net operating assets

Following are some of the disadvantages of using return on net operating assets.

  1. The calculation of this ratio is dependent on the book value of assets and not market value.
  2. The calculation of the net profit (used in the ratio) includes multiples estimates and assumptions. Hence, it may not be logical to rely on loads of assumptions.
  3. The calculation is dependent on the historical data and figures. Hence, it’s about the past performance of the business and not directed towards the future.

The calculation for the net operating assets

Suppose the net profit for the XYZ limited is $3,000, and the following extract is obtained from the balance sheet of the same company.

Particulars $ worth
Inventory 8,000
Accounts receivables 12,000
Cash and bank 2,000
PPE 4,000
Accounts payable 3,000
Other payable 1,000

First, we need to identify the assets from the given figures. The assets from given figures include inventory, accounts receivables, cash balances, and PPE that total $26,000 ($8,000+$12,000+$2,000+$4,000). Similarly, total liabilities stand at $4,000 ($3,000+$1,000).

So, the net assets amount to Operating assets minus operating liabilities.

Net assets = Operating assets – Operating liabilities

Net assets = $26,000-$4,000

Net assets = $22,000

Let’s put the figures in the formula to calculate the return on net operating assets.

Return on net operating assets = Net profit/Net assets

Return on net operating assets = $3,000/$22,000

Return on net operating assets = 13.64%

Since the calculated RNOA is less than 20%, the business does not seem to be an asset incentive because of a lower asset base. So, the business needs to consider how to improve return on net operating assets.

How to improve return on net operating assets

  1. Increase in the net profit – There are two ways to increase the net profit. The first is to increase the efficiency of the asset base and increase revenue. The second way is to control the expenses; the expenses can be controlled for different categories, including the cost of sales, admin expense, marketing, finance, and tax expense. However, the business must not compromise on the quality aspects of operations.
  2. Increase proportion of efficient assets – Purchasing new operating assets can be a good idea to increase RNOA. The science behind the concept is that newly purchased assets are expected to be more efficient than old assets and lead to higher profitability in the long term. Similarly, some assets may be a bottleneck in the process of production. Although the purchase of new assets can lead to a sharp decline in RNOA. However, it results in long-term business efficiency and financial stability.
  3. Sell inefficient operating assets – Selling operating assets can lead to a higher return on net operating assets. It’s because the lower value of the asset base leads to higher RNOA. However, selling operating assets may not be a long-lasting solution if adequate alternate is not provided.

Conclusion

Operating assets are used by the business to generate revenue. Similarly, operating liabilities inflow because of the normal business operations. The net operating asset is calculated by deducting operating liabilities from operating assets.

Return on net asset is an important metric that helps understand if the business is efficient and working at its full potential. Similarly, this ratio is presented in percentage. Hence, it can be compared with different companies to assess comparative performance.

It’s equally important to understand that financial assets are different from operating assets and not included in the calculation’s return on net operating assets. Likewise, the greater value of the return on net assets is more desirable from the financial analysis perspective.

This matric can be improved by taking certain actions like increasing net profit, increasing the proportion of new/efficient assets, and selling inefficient operating assets.

Frequently asked questions

Is RNOA is same as ROA?

RNOA – Return on net operating assets is different from ROA – Return on assets. Return on asset compares the net profit with the total assets, including operational and financial assets. On the other hand, the RNOA compares net profit with net operating assets and does not include financial assets. Although, a higher value of both the ratios is desirable from an analysis perspective.

What’s the difference between Return on Assets and Return on equity?

Return on equity compares net profit with equity. It’s about comparing the shareholder’s/owners investment in the company with the return generated. It’s more relevant matric when investors assess their return on investment.

On the other hand, the return on net assets compares net profit with the operating assets. So, it’s about measuring return about operational assets performance of the business.

Is it logical to compare the return on net assets with the other companies?

Since the return on net assets is percentage-based matric. So, it can be compared with other companies. However, the comparing company must be from the same business sector. The reason is that some industries use expensive asset and their return on net assets is usually lower and vice versa.