Return on operating assets
/What is the Return on Operating Assets?
The return on operating assets measurement focuses attention on only those assets used to generate revenue. Once measured, a common outcome is that management works to minimize all of the other assets on the books that are not contributing to revenue.
How to Calculate the Return on Operating Assets
The formula for the return on operating assets is to divide net income by the gross recorded amount of all assets used to generate revenue. The calculation is as follows:
Net income ÷ Total carrying amount of all revenue-generating assets = Return on operating assets
Several issues related to this calculation are as follows:
Income calculation. It can make sense to use operating income in the numerator, rather than net income, if the net income figure includes large amounts of interest income or interest expense.
Unusual income exclusions. If there is unusual income not related to the ability of assets to generate revenue, exclude it from the numerator.
Asset exclusions. Do not include in the denominator any assets not associated with revenue-generating activities, such as investment assets.
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Example of the Return on Operating Assets
As an example of how the return on operating assets can be used, Giro Cabinetry has acquired a number of assets through various acquisitions that may no longer be needed. The president tells the controller to develop a return on operating assets measurement, with the intent of spotting equipment that can be disposed of. The controller assembles the following information:
Net income for the past year was $500,000
The gross amount of assets on the books is $4,000,000
There are three excess lathes, recorded at $65,000 in total
There are two excess band saws, recorded at $35,000 in total
There is an extra CNC machine, recorded at $300,000
Based on this information, the company's return on operating assets is:
Net income ÷ Assets used to create revenue
=
$500,000 Net income ÷ ($4,000,000 Gross assets - $400,000 Unproductive assets)
= 13.8% Return on operating assets
Problems with the Return on Operating Assets
A concern with the use of this ratio is that a company may strip out assets that were being held in reserve to deal with peak demand situations. If such assets are eliminated, a business may not be able to meet customer orders when demand spikes. This is less of a concern in older markets where demand patterns are well-established; in these environments, asset levels can be finely tuned to match demand.