What is the Return on Net Assets?

The return on net assets (RONA) measure compares net profits to net assets to see how well a company is able to utilize its asset base to create profits. It can also be used to compare the performance of a business to that of a peer group. A high ratio of assets to profits is an indicator of excellent management performance. The RONA formula is to add together fixed assets and net working capital, and divide into net after-tax profits. Net working capital is defined as current assets minus current liabilities. It is best to eliminate unusual items from the calculation, if they are one-time events that can skew the results. The calculation is:

Net profit ÷ (Fixed assets + Net working capital) = Return on net assets

Example of the Return on Net Assets

For example, Quality Cabinets, an old maker of fine mahogany cabinets, has net income of $2,000,000, which includes an extraordinary expense of $500,000. It also has fixed assets of $4,000,000 and net working capital of $1,000,000. For the purposes of the return on net assets calculation, the controller eliminates the extraordinary expense, which increases the net income figure to $2,500,000. The calculation of return on net assets is:

$2,500,000 Net income ÷ ($4,000,000 Fixed assets + $1,000,000 Net working capital)

= 50% Return on net assets

Related AccountingTools Courses

Business Ratios Guidebook

The Interpretation of Financial Statements

Advantages of the Return on Net Assets

There are several advantages to focusing on the return on net assets. They are as follows:

Investment indicator. The measurement can be a good indicator of management performance within an industry, where all competitors should have roughly the same asset base. In this situation, any unusually high returns on net assets would stand out as being indicative of good management practices.
Performance indicator. The measurement can be combined with a knowledge of the business sectors in which a business competes, to judge whether management is doing a good job of only competing in sectors where it can achieve a high return on net assets. When management has entered new markets and the measurement subsequently plunges, this is a good indicator that it has not done a good job of strategic analysis, resulting in less effective usage of its assets.

Problems with the Return on Net Assets

While it can be a useful measure of efficiency, the return on net assets measurement has several limitations and problems. Here are the main issues associated with it:

Short-term focus. Companies may prioritize immediate profitability at the expense of strategic, long-term projects to improve their return on net assets.
Ignores financial leverage. The return on net assets does not account for the impact of financial leverage (debt vs. equity financing). A highly leveraged company might show a high return on net assets, but could be at significant financial risk.
Overemphasis on efficiency. The metric rewards reducing net assets, which can incentivize excessive cost-cutting or asset disposal, even when retaining those assets might be beneficial for the business.
Incentivizes underinvestment. Managers may avoid making investments in new assets (e.g., equipment, facilities) to keep net assets low and artificially inflate RONA, potentially harming long-term growth.
Dependency on accounting policies. The calculation of net assets depends on accounting methods such as depreciation, inventory valuation (FIFO vs. LIFO), and asset impairment, which can vary widely between companies.
Vulnerable to manipulation. Companies can manipulate net assets (e.g., through off-balance-sheet financing or asset revaluation) to present a more favorable return on net assets.
Ignores the cost of capital. This measurement does not consider whether the return on net assets exceeds a company’s cost of capital. A high return on net assets might still fail to create value for shareholders if it doesn’t surpass the weighted average cost of capital.
Impact of asset aging. Older assets that are fully depreciated can distort the return on net assets, because they are recorded at a reduced book value, which artificially increases the ratio without reflecting actual performance.

While the return on net assets can provide a snapshot of efficiency in utilizing net assets, it should not be used in isolation. A comprehensive financial analysis that considers other metrics and factors like industry context, cost of capital, and long-term strategy is essential for accurate performance evaluation.