Return on Operating Assets

Return on operating assets is the rate of return that a company gains by efficiently using its operating assets. Operating assets are the assets in the company's balance sheets that are used for daily operations of the company, unlike financial assets, which are used as an investment or as a balance sheet statement.

Return on operating assets, in short, helps understand how efficiently a company is using the assets that earn revenue for them. The more the returns, the better a company is in utilizing its efforts. If the returns are low, it indicates the companies need to improve their asset utilization strategies.

• Return on operating assets measures the company's profitability from investing in the assets used in daily business activities. In other words, it shows the profit from day-to-day operating assets such as fixed assets, inventory, cash, and accounts receivable. 
• It is an essential ratio used in financial planning and analysis. It is slightly different from Return on Total Assets formula that considers a firm's total assets.
• If a company uses different accounting or depreciation methods, it must adjust the procedure in the financial analysis. 
• The higher ratios show higher profitability. A ratio below 1 indicates the inefficient usage of the operating assets. 

Return on Operating Assets tells the company the amount earned after investing in the operating assets, which are useful in performing day-to-day business operations. It is used to measure the company’s operating profitability and operating assets utilization efficiency. Higher ratios indicate higher profitability, while ratios below 1 mean inefficient use of the operating assets. Nevertheless, ROOA is an important formula for financial analysis.

Operating assets, like cash, inventories, accounts receivables, etc. are used in the daily business operating and help the business grow. However, the returns that organizations receive in return to the investments they make on these assets, lets the companies assess if they assets are worth paying for. Based on how the assets perform, the entities may decide to continue with or remove the assets from being utilized in their business processes.

Return on operating assets is calculated as the percentage return from assets used in the business’s core revenue-generating activities. It is an efficiency ratio, one of the important ratios used in financial planning and analysis.

It is slightly different from the return on total assets formula, which considers total assets owned by the firm. In this case, we only take the current assets, primarily involved in generating revenue. So, it has two broad components: –

• Net Income: Net income involves the residual income of the business, which is left for the distribution to the shareholders.
• Current Assets: : It involves assets like cash, accounts receivables, and other current assets of the company, which are responsible for generating revenue/income.

The formula for return on operating assets is net income over the current investment, expressed in percentage form.

Return on Operating Assets Formula = Net Income / Operating Assets

The higher the return, the better it is for the company. Operating assets include cash, accounts receivable, inventory, and fixed assets that contribute to everyday operations.

Below are some examples to understand this in a better manner.

Example #1

Arabic Construction Ltd. is a growing construction company in the Middle East. It prepares its financial statements using the IFRS reporting standards. By looking at the company’s annual report for the fiscal year 2013, the balance sheet asset number stands at $200,00,00 of which 50% are current. The reported net income for that particular period is $500,000. How can an analyst calculate the return on the operating asset?

Solution:

First, we need to calculate the portion of current assets = 50% of $200,00,00

Current Assets =200,00,00 * 50 =$100,00,00

Calculation of ROOA

= 500,000 / 1,000,000

ROOA =50%

Example #2

XYZ Polymers Ltd. prepares its financial statements per the IFRS reporting standards. By looking at the company's annual report for the fiscal year 2016, the balance sheet asset number stands at $2,500,000, of which 50% are current. The reported net income for that particular period is $10,000. How can an analyst calculate the return on the operating asset?

Solution:

First, we need to calculate the portion of current assets = 50% of $2,500,000

Current Assets= 2500000*50=$1,250,000

Calculation of ROOA

=10,000 / 1,250,000

ROOA =1%

When the return on operating assets is high, it indicates that the operating assets are being utilized in the right way and it would be wise to continue investing in them. On the other hand, if the figure obtained is low, it helps businesses understand that it is not a wise decision to invest in keeping and maintaining those assets. Hence, they remove or replace such assets.

If the return is above 5%, it is considered good, while more than 20% is considered an excellent return percentage. These returns on the financial statements are verified against the number of operating assets, thereby helping assess the real financial position of a company in the market. As a result, making investment decisions becomes easier further for interested investors.

The return on operating assets has a lot of benefits as it allows businesses to keep track of the performance of the assets it invests in for a smooth business functioning.

Let us have a look at some of the advantages of obtaining this value:

• The formula is used in the industry to calculate the return on the asset. It is an important return ratio matrix for the investors and the shareholders. It is used for financial ratio comparison and peer group analysis.
• It is different from the return on total assets. The analysis becomes more meaningful because it considers only those assets used to generate revenue and operate day-to-day business.

Despite having so many benefits, obtaining the returns on operating assets also have some challenges, which include the following:

• Since the formula considers the asset’s book value, it significantly understates the asset’s value from the actual market value of those assets.
• The procedure needs to be adjusted in the financial analysis if companies use different accounting methods or depreciation methods for purchasing assets.

This article has been a guide to Return on Operating Assets and its Definition. We explain the concept with its formula, and discuss how to calculate with interpretation. You can learn more about financing from the following articles: –

• ROE vs. ROA
• Return on Sales Ratio
• RONA
• Journal Entry of Sales Return