Updated July 21, 2023
Introduction to Return on Operating Assets
Return on Operating Assets can be defined as an efficiency ratio that measures the percentage return an organization earns from the money that it has invested in the operating assets, or in other words, it is the ROR or rate of return that an organization gains from efficient utilization of operating assets such as cash, inventory, accounts receivables and fixed assets that are used for day to day operations.
Formula
The formula used for calculating the ROOA is as follows:
Where,
- Net Income is the income of the company which is available for distribution to the shareholders. This figure is available in the income statement of the company.
- Operating Assets are the assets that are acquired by the company for the purpose of conducting its ongoing operations. The figure for the operating assets of the company is available in the company’s balance sheet.
Explanation
This is used to measure the profit earning ability of an organization from its production resources that are used on a day to day basis. It can also be understood as a ratio between net income and operating assets of an organization. Higher ROOA indicates a higher profit earning ability of an organization.
Examples of the Return on Operating Assets
Below are the examples to calculate ROOA:
Example #1
During a year the income statement of the ABC Company showed the net income of $1,500,000 and its balance sheet showed the total assets of $10,000,000. Out of the total assets, the operating assets of the company are $8,500,000 as per its balance sheet for the year. Calculate the ROOA of the company for the year.
Solution:
Step #1
- Calculation of the Net Income for the year of the ABC Company
- The total amount of net income of the ABC Company during the year under consideration is $1,500,000.
Step #2
- Calculation of the total amount of operating assets of the ABC Company
- The total amounts of operating assets of the ABC Company as per its balance sheet are $8,500,000.
Step #3
Return on Operating Assetsl is calculated as
Return on Operating Assets = Net Income / Operating Assets
- Return on Operating Assets = $1,500,000 / $8,500,000
= 17.65%
Hence, ROOA for ABC Company is 17.65%
Example #2
The figures related to the net income (taken from the income statement of the company) and the operating assets (taken from the balance sheet) of the company for the two years are given below.
| Year | Net Income | Operating Assets |
| 2018 | $5,840,000 | $15,984,500 |
| 2019 | $6,845,600 | $17,050,240 |
Calculate the ROOA of the company for those years.
Solution:
Year 2018,
Step #1
- Calculation of the Net Income for the year:
- The total amount of net income of the Company during the year under consideration is $5,840,000.
Step #2
- Calculation of total amount of operating assets
- The total amounts of operating assets of the Company as per its balance sheet are $15,984,500.
Step #3
Return on Operating Assets is calculated as
Return on Operating Assets = Net Income / Operating Assets
- Return on Operating Assets = $5,840,000/ $15,984,500
= 36.54%
Hence, ROOA for Company is 36.54%.
Year 2019,
Step #1
- Calculation of the Net Income for the year
- The total amount of net income of the Company during the year under consideration is $6,845,600.
Step #2
- Calculation of total amount of operating assets
- The total amounts of operating assets of the Company as per its balance sheet are $17,050,240.
Step #3
Return on Operating Assets is calculated as
Return on Operating Assets = Net Income / Operating Assets
- Return on Operating Assets = $6,845,600 / $17,050,240
= 40.15%
Hence, ROOA for Company is 40.15%
Advantages and Disadvantages of Return on Operating Assets
Below are the advantages and disadvantages of Return on Operating Assets:
Advantages
- ROOA is an important efficiency ratio used for the purpose of calculating the profitability of an organization.
- This is an important ratio that is used in measuring the percentage return that an organization earns from the funds that are invested in the resources that are used for day to day business operations.
- It helps the equity holders and other investors of an organization in determining the return ratio of an organization and they also take the same into use for comparing financial ratios with the arch-rivals of the same.
- It is a more meaningful ratio as it considers operating assets, i.e. production resources that are taken into use for the purpose of generation of revenues and are used for day to day business operations.
Disadvantages
- This formula considers assets at their book value and happens to ignore and understate the market value of the assets. This results in a higher ratio that depicts the fact that the return of total assets is higher than what was supposed to be as the denominator or the value of operating assets is too low.
- If a company uses different methods of accounting or depreciation method for the operating assets then the ROOA formula will need to be accordingly adjusted.
Conclusion
ROOA is the short form used. This is an efficiency ratio that is taken into use for calculating the percentage return an organization actually earns from investing its funds in assets that contribute to daily operations. In other words, it can be expressed as a ratio between net income and operating assets. Cash, fixed assets, inventory, and account receivables are fine examples of operating assets. This is a very crucial and significant formula used for the purpose of financial planning as well as analysis. ROOA allows the investors of an organization in measuring the return ratio that can be used for comparing financial ratios with the competitors of the same.
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