What is Return on Net Assets (RONA)?
Return on net assets (RONA) is defined as the financial ratioFinancial RatioFinancial ratios are indications of a company's financial performance. There are several forms of financial ratios that indicate the company's results, financial risks, and operational efficiency, such as the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratio, stability ratios, and so on. of the net income earned by the business to the overall total of net fixed assets and net assets held by the business. The financial metric tries to analyze how much revenue a business is able to generate by employing specific assets for its business operations. It further helps in analyzing how effectively the assets are utilized and deployed by the management and company to derive economic value for the business.
Components of Return on Net Operating Assets
#1 – Physical Assets
Physical assets are defined as the fixed assetsFixed AssetsFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples. which the business employs in running business operations. These could be in the form of the production plant, machinery, business property, investment propertyInvestment PropertyInvestment property refers to the real estate acquired to earn returns on the investment through rental income, royalties, dividends or future appreciation, usually in the name of an individual investor, a group of investors or an investment company for a short-term or a long-term investment., or equipment. These are non-current assetsNon-current AssetsNon-current assets are long-term assets bought to use in the business, and their benefits are likely to accrue for many years. These Assets reveal information about the company's investing activities and can be tangible or intangible. Examples include property, plant, equipment, land & building, bonds and stocks, patents, trademark. and can be found in the balance sheet section of the business.
#2 – Current Assets
Current AssetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc. are the basic component of the networking capital of the business. These are composed of cash, marketable securitiesMarketable SecuritiesMarketable securities are liquid assets that can be converted into cash quickly and are classified as current assets on a company's balance sheet. Commercial Paper, Treasury notes, and other money market instruments are included in it., and inventories. These are assets held by the business for the current financial year of the business.
#3 – Current Liabilities
The current liabilitiesCurrent LiabilitiesCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They're usually salaries payable, expense payable, short term loans etc. are obligations that the business has to pay within 12 months or the current financial year of the business. They are composed of notes payable, account payableAccount PayableAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period. and current portion of long-term debtCurrent Portion Of Long-term DebtCurrent Portion of Long-Term Debt (CPLTD) is payable within the next year from the date of the balance sheet, and are separated from the long-term debt as they are to be paid within next year using the company’s cash flows or by utilizing its current assets., accruals, etc. These are deducted from the current assets to arrive at the networking capital, which in turn can be utilized to calculate the return on net assets.
#4 – Net Income
Net income is defined as the residual income earned by the business. It is the end value a business gets when all the operational overheads, the cost of running a business are deducted from the revenue generated by the business. It can be found in the income statement sectionIncome Statement SectionThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements. of the business.
Return on Net Assets Formula
The return on net operating assets (Rona) formula can be determined using the time value of moneyTime Value Of MoneyThe Time Value of Money (TVM) principle states that money received in the present is of higher worth than money received in the future because money received now can be invested and used to generate cash flows to the enterprise in the future in the form of interest or from future investment appreciation and reinvestment. relationship as described below:
- The Physical Asset is represented by PA.
- The Current Assets are represented by CA.
- The Current Liabilities are represented by CL.
Below are the examples of return on net assets (RONA).
Suppose the company earns a net income of $560,000 during its business operationsBusiness OperationsBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company's goals like profit generation.. The business additionally has a net working capital of $200,000 and holds physical assets worth $1,000,000.
RONA can be determined as follows: –
Therefore, the company has generated a RONA of 0.467 from its business operations. This further means that the business is unable to generate revenues properly and is delivering fair performance.
Suppose the company earns a net income of $570,290 during its business operations. The business additionally has net working capital of $100,000 and holds physical assets worth $600,000.
RONA would be determined as follows: –
Therefore, the company has generated RONA of 0.8147 from its business operations. This further means that the business is able to generate revenues properly and is delivering good performance as well as favorable returns for its owners.
A business for its current financial year generated a return on net assets as 0.867. Therefore, it could be inferred that the business employed its physical assets and the net working capitalNet Working CapitalThe Net Working Capital (NWC) is the difference between the total current assets and total current liabilities. A positive net working capital indicates that a company has a large number of assets, while a negative one indicates that the company has a large number of liabilities. efficiently to drive value and net income of 87 cents approximately. It further means that the net income generated by the business equals 87% of the overall combined value of physical assets and the networking capital of the business.
- It is useful for the manufacturing business as it helps them to collect and maintain information on sales, assets, and operational costs at the plant level.
- It helps the investor know whether the business is a good investment option or not.
- A high ratio always signifies that the company is highly efficient in driving good business.
- Since the metric is derived using fixed assets. Therefore, the method of depreciation employed by the business in determining the net fixed assets affects the comprehensive determination of return on net assets.
- A wrong depreciation method can severely skew the profitability ratio or RONA.
- If the business earns loss from unusual and unpredictable events, then also it can skew the return on operating assets metric. Since such losses would be adjusted to the net income and can, therefore, deliver an adverse impact on the value of the ratio.
- It does not account for intangible assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. as it is eliminated from the calculations.
- It helps the business determine its ability to create and derive value creation for the longer-term horizon.
- It helps the business determine how well they utilize physical assets and net assets.
- A high RONA is generally regarded as a favorable metric for the business.
- It is one of the comprehensive measures wherein net income is compared with the physical assets of the business.
- If a business incurs significant one-time losses, then it can be adjusted to the net income earned by the business to derive the value of the return on net assets (RONA).
Return on Net Assets is regarded as the performance metric, which compares the net income generated by the business over the physical assets utilized by the business. It helps analysts and business knowledge and determines whether the company is able to drive an efficient business operation to generate good economic value.
The investors utilize this ratio to determine whether they would be able to earn good returns or not if they were to invest their money in the business.
This article has been a guide to Return on Net Assets. Here we discuss components, the formula of return on net assets (RONA) along with examples, advantages & disadvantages. You can learn more financial analysis from the following articles –