Return on Operating Assets Definition
Return on Operating Assets is defined 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 analysis.
Return on Operating Assets Formula
In order to calculate Return on Operating Assets, 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 residual income of the business which is left for the distribution to the shareholders.
- Current Assets: Current Assets involves those assets like cash, accounts receivables, and other current assets 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.
The higher is the return, the better it is for the company. Some examples of operating assets include cash, accounts receivable, inventory and the fixed assets that contribute to everyday operations.
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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 statements 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 Assets =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 comparison 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 methods 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 profitability, while ratios below 1 mean inefficient use of the operating assets. Nevertheless, ROOA is an important formula for financial analysis.
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