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 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 uses its capital to generate profit.
Improve Return on Net Operating Assets
Company always look for a way to boost this ratio to show off their performance. There are several ways to do it:
- Increase net income: this is the most common suggestion when it comes to improving performance. To increase net income, we should increase sales by capturing more market share, and 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.
Type of Operating Assets
Cash
Cash is the lifeblood of any business, and without it, a business will quickly go bankrupt. In order to keep track of cash, businesses need to maintain internal control for both physical and reporting control. This system tracks all financial transactions and ensures that there is always an accurate record of cash on hand. Additionally, businesses need to establish strong internal controls over their cash management processes.
Accounts Receivable
Accounts receivable is defined as money owed from customers for goods or services that have been sold on credit. Typically, businesses allow their customers a certain period of time to pay the outstanding balance. Accounts receivable are considered to be an asset on the balance sheet, as it represents money that will eventually be received by the company. However, if customers fail to pay their outstanding balances, the receivables can turn into bad debt, which is a loss for the company.
Inventory
Inventory can be defined as the items that company purchases or produce for the purpose of reselling to customers. This can include everything from raw materials to finished products. For businesses, inventory is a crucial part of operations, as it represents the company’s invested capital and its ability to generate revenue. Therefore, businesses must carefully manage their inventory levels to ensure that they are neither overstocked nor understocked. In practice, this often involves maintaining a delicate balance between the cost of holding inventory and the risk of stockouts.
Fixed Assets
A fixed asset is a long-term piece of property or equipment that a company owns and uses in its operations. Fixed assets are not intended for sale, but rather they are leased out or used to produce goods and services that generate revenue for the business. The term “fixed” refers to the fact that these assets are not easily converted into cash like other types of assets such as inventory or accounts receivable. As a result, businesses must carefully consider how to finance the purchase of fixed assets in order to avoid putting strain on their cash flow.
Type of Operating Liabilities
Accounts Payable
Accounts payable is the amount a company owes to its suppliers for goods or services. When a company purchases goods on credit, it records an accounts payable. Once the goods are received, the company records the expense in its accounting records. The amount owed is paid to the supplier at which point the liability is extinguished. Accounts payable is typically one of the largest liabilities on a company’s balance sheet. For this reason, it is important for companies to carefully manage their accounts payable in order to avoid defaulting on their obligations.
Accrued Liability
An accrued liability is a financial obligation that has been incurred but has not yet been billed from the suppliers. This can occur when goods or services have been received but the bill has not yet been paid. Accrued liabilities are recorded on a company’s balance sheet as part of the current liabilities section. These obligations represent a legal responsibility of the company and must be paid in a timely manner. Failure to do so could result in late fees, legal penalties, or damage to the company’s credit score.
Income tax Liability
An income tax liability is the amount of money that a person or entity owes to the government in taxes. This can be calculated based on the company’s taxable income, which is the total amount of money earned minus any deductions or exemptions. The tax liability will also vary depending on the tax rate, which is set by the government. Generally, the higher the taxable income, the higher the tax liability will be.
