Return on Operating Assets

Definition

The term return on operating assets refers to a measure that allows the investor-analyst to understand the return a company is generating from assets used to create revenues. Generally, companies track return on operating assets over time to identify opportunities to eliminate waste and unnecessary assets.

Calculation

Return on Operating Assets = Net Income / Operating Assets

Where:

• Operating assets are those directly involved in the production of revenue. Typically, these assets would include plant machinery and other equipment used in the manufacture of a product.
• Assets are typically stated net of book depreciation, since depreciation for tax purposes may be accelerated.

Explanation

Return on investment measures allow the investor-analyst to understand the company's ability to provide investors with an acceptable return on their money. This is usually assessed by examining metrics such as net worth, returns on equity or assets, earnings, economic value added, and dividends. Return on investment metrics provide analysts with a way to determine a fair price to pay for a share of common stock. One of the ways to understand return on investment is by measuring a company's return on operating assets.

Companies will track metrics like return on operating assets over time, since this value is a good indicator of production efficiency. The metric divides net income by assets used to create revenue. Ideally, a company will see this metric increase if they improve their production processes, including the use of more efficient machines. Of particular importance is to remove any extraordinary items from net income, so their effect does not influence the metric. It's also important that a committee review and approve the assets used in the denominator, since the objective of the measure can be to eliminate an unneeded asset, a manager can protect that asset from elimination by not including it in the measure.

Example

Company ABC's new chief operating officer asked the company's finance team to work with operations and establish a framework for understanding the efficiency of the company's machinery used in making the company's products. The team recommended a historical view of the company's return on operating assets, since a number of process improvement efforts were undertaken by operations. The CFO asked her analytical team to calculate the metric over the past three years. The biggest hurdle the team encountered was the decision on the assets to include in the denominator of the metric

The CFO's team presented the following information to Company ABC's CEO:

 Year 0 Year 1 Year 2 Net Income \$6,676,000 \$7,074,000 \$7,490,000 Total Fixed Assets \$61,817,000 \$63,729,000 \$65,700,000 Less: Unproductive Assets \$38,017,000 \$42,329,000 \$44,300,000 Operating Assets \$23,800,000 \$21,400,000 \$21,400,000 Return on Operating Assets 28.1% 33.1% 35.0%

Based on these finding, the CEO asked the team to consider additional continuous improvement projects to further increase the company's return on operating assets or report back if additional efforts might not yield additional gains.