What assets are considered an operating asset in return on investment computations?

Return on Operating Assets Definition

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 Formula

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 ratioEfficiency ratios are a measure of how effectively a company manages its assets and liabilities and include formulas like asset turnover, inventory turnover, receivables turnover, and accounts payable turnover.read more, one of the important ratios used in financial 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 formulaReturn on Total Assets is a measure of a company's income proceeds left for shareholders divided by the total assets owned by the company. ROA = Net Income/Total Assets.read more, 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 IncomeNet income for individuals and businesses refers to the amount of money left after subtracting direct and indirect expenses, taxes, and other deductions from their gross income. The income statement typically mentions it as the last line item, reflecting the profits made by an entity.read more: Net income involves the residual 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 of the business, which is left for the distribution to the shareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares.read more.
• Current Assets: : It involves assets like cash, accounts receivablesAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. read more, and other 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 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

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For eg:
Source: Return on Operating Assets (wallstreetmojo.com)

The higher the return, the better it is for the company. Operating assets include cash, accounts receivable, inventory, and fixed 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 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 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 using the IFRSIFRS or International Financial Reporting Standards refers to a globally-accepted set of accounting and financial reporting guidelines for preparing and presenting financial statements. It ensures uniformity in accounting practice that makes financial records comparable across different reporting entities worldwide. Over the years, it has emerged as the new world standard in accounting.read more reporting standards. By looking at the company’s annual report for the fiscal yearFiscal Year (FY) is referred to as a period lasting for twelve months and is used for budgeting, account keeping and all the other financial reporting for industries. Some of the most commonly used Fiscal Years by businesses all over the world are: 1st January to 31st December, 1st April to 31st March, 1st July to 30th June and 1st October to 30th Septemberread more 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 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 =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 reportAn annual report is a document that a corporation publishes for its internal and external stakeholders to describe the company's performance, financial information, and disclosures related to its operations. Over time, these reports have become legal and regulatory requirements.read more for the fiscal year 2016, the balance sheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more 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%

Advantages

• 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 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 assetsTotal Assets is the aggregate of liabilities and shareholder funds. It can also be computed by combining current and noncurrent assets.read more. The analysis becomes more meaningful because it considers only those assets used to generate revenue and operate day-to-day businessBusiness 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.read more.

Limitations

• 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 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 Depreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year. read more purchasing assets.

Conclusion

ROOA is used to measure the company’s operating profitability and operating assets utilization efficiency. Higher ratios indicate higher profitabilityProfitability 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 analysisFinancial analysis is an analysis of finance-related projects/activities, company's financial statements (balance sheet, income statement, and notes to accounts) or financial ratios to evaluate the company's results, performance, and trends, which is useful for making significant decisions such as investment, project planning and financing activities.read more.

Recommended Articles

This article has been a guide to Return on Operating Assets. Here we discuss how to calculate Return on Operating Assets and examples, advantages, and limitations. You can learn more about financing from the following articles: –

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