Net Operating Assets

Net Operating Assets are the company operating assets less operating liabilities. It is one of the methods to evaluate the company base on operating activities.

Operating assets are the company’s assets that use in operation to generate income, including cash, inventory, property plant & equipment, accounts receivable, prepaid expense, and required intangible assets. They exclude the financial instrument, long-term investment, Loan & receivable, and unutilized fixed assets. The ratio of total assets to operating assets shows how effectively the company uses its own assets to generate revenue.

Operating Liabilities are the company’s short-term debt that results from the business operation. In practice, the company may owe to supplier, employee, or government. The company does not need to pay interest on such kind of liabilities. They include Accounts Payable, Accrued Liability, Income Tax Payable. Operating Liabilities exclude long-term debt, bonds, and other long-term loans.

Net Operating Assets Formula

Net Operating Assets Example

For example, Company A has a total asset of $ 10 million and share capital of $ 7 million. The company has financial instrument and investments in a subsidiary of $ 2 million. They also have outstanding debt of $ 1 million to the bank.

Operating Assets = $ 10 million – $ 2 million = $ 8 million We exclude the financial instruement and investment in subsidiary.

Operating Liabilities = $ 3 million – $ 1 million = $ 2 million We exclude the the long-term debt.

Net operating Assets = $ 8 million – $ 2 million = $ 6 million

Return on Net Operating Assets (RONA)

Return on Net Operating Assets is the financial ratio which use to evaluate company performance. Similar to Return on Assets, Return on Net Operating Asset calculate the percentage of return from company’s assets which are supposed to generate a sale. It is more reasonable as we focus on the operating assets and exclude any other assets such as investments that are not related to company performance. RNOA focuses on the primary business activities of the company by excluding other factors that are not under control. It will reflect with actual performance.

\[Return\ on\ Net\ Operating\ Assets = {Net\ Income \over Net\ Operating\ Assets}\]

Return on Net Operating Assets Analysis

Return on Net Operating Asset helps the investors to calculate the company’s ability to generate profit by using the equity. It clearly separates the return of daily operation from the return of investment. It is very important as the company has direct control over its business. The investors really want to know how the company using its capital to generate profit.

Improve Return on Net Operating Assets

Company always look for a way to boost this ratio to show off the performance. There are several ways to do it:

  • Increase net income: this is the most common suggestion when it comes to improve performance. To increase net income, we should increase sales by capturing more market share, maintain existing customers to reduce customer churn rate. At the same time, company should consider reducing unnecessary expenses to increase net income. However, we must make proper decisions to ensure there is no negative effect when reducing expenses.
  • Purchase more operating assets: Some assets may be too old to operate at full capacity. They will become the bottleneck which limits the production quantity. So we should consider investing in new operating assets. However, it will decline our RONA in short run, but it will pay off in long run.
  • Sell operating assets: yes it makes sense in mathematic, it will increase RONA in short run. But it will have a long-term impact as the sale will decline if we sell fulls functional operating assets which decreases production. We should only sell old assets and replace them with new ones.

Advantage of Return on Net Operating Assets

  • It helps investors to do future analyses of the company’s performance. It shows how effective the company uses net operating assets to generate a net profit.
  • Not easy to manipulate: As we know the company intends to make their financial statement look good, so they will try to manipulate the reports. However, RONA relies on the result of company performance (net income) and net operating assets, so it is very hard for them to make any change if they wish to.
  • Easy to compare across different industries: The nature of ROA allows investors to compare company performance across different industries so they could make precise decisions.

Disadvantages of Return on Net Operating Assets

  • Base on history data: Both net income and net operating asset base on the financial statement which is the historical data.
  • Net income is the result of company performance but it arrives from the accounting estimate and management assumption
  • Asset and liabilities depend on the book value rather than market value.

Negative Net Operating Assets

Negative Net Operating Assets mean that the company operating liability is greater than operating assets. It means the company is really in big trouble, their operating assets are less than operating liabilities and they may face liquidity as they lack the cash to pay off liabilities.