Return is the income an investor receives on their investment. It can be in the form of fixed income generated from the underlying asset. For example, dividends and interest receipts are a form of fixed income on instruments. However, a return can also come as capital gains or losses. Companies also use a return to calculate the wealth generated for their shareholders.
Companies use different metrics to understand how much resources go into generating income. One of these includes the return on net operating assets.
What is the Return on Net Operating Assets?
This term, return on net operating assets, refers to the income companies get from their net operating assets. As discussed in this article, these assets refer to the resources invested in a company’s core operations. Its calculation involves subtracting non-operating assets and non-operating liabilities from total assets and liabilities.
Return on net operating assets measures a company’s financial performance by using its net operating assets. While companies can calculate their returns on total assets, this metric provides a more relevant measure of profitability. Essentially, return on net operating assets gives better insights into the use of operating resources to generate profits.
What is the formula for Return on Net Operating Assets?
The formula for return on net operating assets is straightforward. It involves dividing operating income over net operating assets. However, it requires calculating the latter first. As previously discussed, the formula for net operating assets is as follows.
Net Operating Assets = Operating Assets – Operating Liabilities
Once companies calculate the net operating assets, they can use it in the formula for return on these assets. Alternatively, they can also put the above equation into the calculation directly. The first return on net operating assets formula is as below.
Returns on Net Operating Assets = Operating Income / Net Operating Assets
Similarly, companies can also use the following alternative formula for return on net operating assets.
Return on Net Operating Assets = Operating Income / (Operating Assets – Operating Liabilities)
Regardless of the return on net operating assets formula, the calculation provides the same ratio. The operating income in both comes from the income statement, usually as a separate line item. On the other hand, the operating assets and liabilities come from the balance sheet and may require additional calculations.
Example
A company, Red Co., generated an operating income of $100,000 during a fiscal period. At the same time, the company had net operating assets of $500,000. Based on the above, the return on net operating assets for Red Co. is as follows.
Returns on Net Operating Assets = Operating Income / Net Operating Assets
Returns on Net Operating Assets = $100,000 / $500,000
Returns on Net Operating Assets =0.2 or 20%
Interpreting the above metric is not as straightforward since it does not provide insights into Red Co.’s operations. The company must use the ratio comparatively to interpret the results better. Usually, it requires comparisons with past periods, competitors, and industry standards.
Conclusion
Return on net operating assets is metric companies use to measure their operating efficiency. Unlike other ratios, it focuses on net operating assets, which provides better insights into how a company utilizes its resources. However, companies cannot use the ratio on its own. Instead, they must compare it with others to understand it better.
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