Return on Operating Assets Definition
Return on operating assets is the rate of return that a company gains by having it’s operating assets into efficient use; operating assets are the assets in the balance sheets of the company 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 Formula
Return on Operating Assets is calculated as the percentage return from assets that are used in core revenue-generating activities of the business. It is an efficiency ratio, which is one of the important ratios used in financial planning and analysisFinancial Planning And AnalysisFinancial planning and analysis (FP&A) is budgeting, analyzing, and forecasting the financial data to align with its financial objectives and support its strategic decisions. It helps investors to know if the company is stable and profitable for investment.read more.
It is slightly different from the return on total assets formula, which takes into consideration total assets owned by the firm. In this case, we only take the current assets which are primarily involved in generating revenue for the business. So it has two broad components: –
- Net Income: Net income involves the [wsm-tooltip header="Residual Income" description="Residual income refers to the net earnings an organization possess after paying off the cost of capital. It is acquired by deducting the equity charges from the company's net profit or income." url="https://www.wallstreetmojo.com/residual-income-formula/"]residual incomeResidual IncomeResidual income refers to the net earnings an organization possess after paying off the cost of capital. It is acquired by deducting the equity charges from the company's net profit or income.read more[/wsm-tooltip] of the business, which is left for the distribution to the shareholders.
- Current Assets: Current Assets involve those assets like cash, accounts receivables, and other current assetsOther Current AssetsOther current assets refer to the category of assets which record all the uncommon and insignificant assets readily convertible into cash and doesn't fit in any common current assets categories like cash & cash equivalents, inventory, trade receivables, etc.read more of the company, which is responsible for the generating of revenue/ income.
The formula for return on operating assets is net income over the current asset, and it is expressed in percentage form.
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For eg:
Source: Return on Operating Assets (wallstreetmojo.com)
The higher is the return, the better it is for the company. Some examples of operating assets include cash, accounts receivable, inventory, and 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.read more that contribute to everyday operations.
Calculation of Return on Operating Assets (with Examples)
Below are some of the examples to understand this in a better manner.
Example #1
Arabic construction limited is a growing construction company in the middle east, and they prepare their financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more are the IFRS reporting standards. By looking at the annual report of the company for the fiscal year 2013. The balance sheet asset number stands at $2,000,000, out of which 50% are of current nature. The reported Net income for that particular period is $500,000. Does an analyst want to calculate the Return on the operating asset?
Solution:
First we need to calculate the portion of current assets = 50% of $2,000,000
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.read more =2,000,000 *50 =$1,000,000
Calculation of ROOA
= 500,000 / 1,000,000
ROOA =50%
Example #2
XYZ polymers limited is a prepare their financial statements are the IFRS reporting standards. By looking at the annual report of the company for the fiscal year 2016. The balance sheet asset number stands at $2,500,000, out of which 50% are of current nature. The reported Net income for that particular period is $10,000. Does an analyst want to 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%
Advantages
- The formula is used in the industry to calculate the return on the asset, which is an important return ratio matrix for the investors and the shareholders, and it is used for financial ratio comparisonFinancial Ratio ComparisonFinancial 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.read more and peer group analysis.
- It is different from the return on total asset, and the analysis becomes more meaningful because it takes into consideration only those asset that is actually used for the generation of revenue and operating in the day to day business.
Limitations
- Since the formula takes into consideration the book value of the asset, it significantly understates the value of the asset from the actual market value of those assets.
- The formula needs to be adjusted in the financial analysis if companies use different accounting methodsAccounting MethodsAccounting methods define the set of rules and procedure that an organization must adhere to while recording the business revenue and expenditure. Cash accounting and accrual accounting are the two significant accounting methods.read more or depreciation methods for the assets.
Conclusion
ROOA is used to measure the company’s operating profitability and operating assets utilization efficiency. Higher ratios indicate higher profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance.read more, while ratios below 1 mean inefficient use of the operating assets. Nevertheless, ROOA is an important formula for financial analysis.
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