Return on Operating Assets (ROOA)
The return on operating assets (ROOA) is a ratio that shows how efficient a company is in using its revenue-earning assets. These are assets used in its day-to-day operations. This value is often calculated to determine the income generated by these assets. And it considers reducing the use of those that do not generate revenue. Put simply, the return on operating assets measures a company’s profitability.
A higher ratio indicates a more efficient use of its revenue-raising assets. The ultimate purpose of any business is to make money, so measuring the return on operating assets to know which areas of operation need improvement, can promote long-term success.
As with most other financial calculations, standard ratios such as this can vary across the industries, so it’s important to make comparisons when deciding whether or not a value is reliable.
Return on Operating Assets Formula
The return on operating assets formula is not the same as the return on total assets formula. That formula takes into account all assets of a company, income-earning or not. Only current assets that directly participate in the business’ revenue-earning activities will be considered with ROOA.
The return on operating assets formula also involves two key components. Net income is the company’s residual income to be distributed as shareholder dividends. Current assets, or assets mainly responsible for revenue generation (cash, accounts receivables, etc.).
There are, however, two issues that must be considered in a return on operating assets calculation. One is depreciation, which should not be included in the denominator as accelerated depreciation can lead to skewed results. The other is unusual income. This should be excluded from the numerator if it has nothing to do with an asset’s income-raising capacity.
Moreover, there can be varied interpretations of the assets that go into the denominator. Managers may assume they will be questioned for assets they leave out of the calculation. Because of this, they will probably include as many assets as they can just to avoid the trouble of explaining an exclusion.
Return on Operating Assets Example
Ed’s Guitars has accumulated several assets over the years, some of which Ed suspects are no longer useful. Before he starts to dispose of things, he wants to make sure they are no longer needed. So, he instructs his team to measure his company’s return on operating assets ratio. To calculate this value, the team dug into the company’s books for the past year. They took note of the following figures: $250,000 (net income); $2,000,000 (gross amount of assets); and $200,000 (total worth of excess equipment). What is Ed’s Guitar’s return on operating assets?
Let’s break it down to identify the meaning and value of the different variables in this problem.
- Net income: $250,000
- Operating assets: $1,800,000
We can apply the values to our variables and calculate the return on operating assets:
In this case, Ed’s Guitars would have a return on operating assets of 13.89%.
This shows the guitar manufacturer’s net income last year was equivalent to only 13.89% of its operating assets. This is not a very efficient ratio. It means Ed and his team should think of ways to boost their operational efficiency. They can do this by buying better machines or investing in technology to increase their productivity, allowing them to earn more from their operating assets.
Return on Operating Assets Analysis
Revenue-earning assets are a must for any business operation, and the value-added by these vital assets to the company can be measured by calculating the return on operating assets ratio. Besides, if a certain piece of expensive equipment is making zero to little contribution to revenue, replacing it with something cheaper yet equally effective would make perfect sense.
Comparing the return on operating assets to the Return on Total assets is also a good way to determine which assets are advantageous to keep. Total assets include long-term assets and investments that have no direct role in raising revenues and are hardly liquid. By exclusively considering operating assets, whose costs are easier to control, income can be increased by improving or enhancing existing processes.
Because income powers investor returns, shareholders are eager to know the company’s return on these investments too. They don’t care that much about book value, which covers all assets, unless there’s income. Hence, this ratio is always under their close watch.
It must be noted that since the return on operating assets formula uses net income, many issues can impact the ratio, such as the cost of goods sold, utility costs, and worker salaries. This also makes the ratio a highly sensitive metric.
Furthermore, it is important to assess changes in the return on operating assets within a certain period, especially if the figure is going down. Management can rely on this ratio to separate the most profitable assets from those that the company would be better off selling or discarding. An innovative way of doing this is to match certain operating assets with particular earnings and costs.
Management can also decide to shift to another industry according to the equipment needed to manufacture a specific product. For example, if the equipment is too pricey with limited returns, it would be wise to sell it and explore a new market. And shareholders can use this metric to differentiate between good and bad investment decisions by management; air their issues when the figure continues to drop over time, and compare their return on operating assets numbers with the ratios of competing businesses.
Return on Operating Assets Conclusion
- The return on operating assets measures a company’s efficiency by the profits it gains from operating assets.
- This formula requires two variables: net income and operating assets.
- The return on operating assets is usually expressed as a percentage.
- A higher return on operating assets means a company is earning more income from its operating assets.
- The return on operating assets uses net income, so it’s affected by several factors including salaries and utility expenses.
Return on Operating Assets Calculator
You can use the return on operating assets calculator below to quickly calculate your company’s income-generating efficiency using your operating assets by entering the required numbers.
1. What is the Return On Operating Assets (ROOA)?
The return on operating assets (ROOA) is a financial metric used to assess the profitability of a company's operating assets. The ROOA measures the amount of net income generated by a company's operating assets, expressed as a percentage of the company's total assets.
2. How do you calculate the Return On Operating Assets (ROOA)?
The return on operating assets can be calculated using the following formula: Return on Operating Assets = Net Income / Operating Assets
3. What are examples of the Return On Operating Assets (ROOA)?
Some examples of the return on operating assets include: The percentage of net income generated by a company's operating assets. The amount of net income generated by a company's cash and equivalents. The amount of net income generated by a company's accounts receivable. The amount of net income generated by a company's inventory. The amount of net income generated by a company's plants and equipment.
4. What are the problems with the Return On Operating Assets (ROOA)?
There are several potential problems with the return on operating assets, including: The metric does not consider a company's long-term investments or assets that are not directly involved in revenue-generating activities. The metric may be skewed if a company has a large amount of debt. The metric may be skewed if a company has significant non-cash expenses, such as depreciation or amortization. The metric may be skewed if a company has significant one-time expenses or gains.
5. What is a good Return On Operating Assets ratio (ROOA)?
There is no definitive answer as to what constitutes a good ROOA ratio. However, a higher ratio is typically considered better, as it indicates that the company is more profitable in terms of its operating assets. Ratios that are lower than those of competing businesses may be cause for concern.