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Return on Operating Assets
Description: The return on operating assets measure only includes in the denominator those assets actively used to create revenue. This focuses management attention on the amount of assets actually required to run the business, so that it has a theoretical targeted asset level to achieve. A typical result of this measurement is an ongoing campaign to eliminate unnecessary assets.
Formula: To calculate the return on operating assets, divide net income by the gross valuation of all assets used to create revenue. You can also use an asset valuation that is net of depreciation, but the type of depreciation calculation used can skew the net amount significantly, since some accelerated depreciation methods can eliminate as much as 40% of an asset’s value in its first full year of usage. Also, if a significant proportion of net income is comprised of income or losses due to extraordinary items that have nothing to do with ongoing revenue creation, then the impact of these items should be eliminated from net income for the purposes of the calculation.
Example: Quality Cabinets, an old maker of fine mahogany cabinets, has accumulated a number of pieces of equipment over the years that are only occasionally used in the production process. The new CFO suspects that there is considerable equipment redundancy, and some degree of protectiveness by the staff of the older pieces of equipment, some of which are old enough to have value as antiques (the equipment, not the staff). The company had income of $230,000 in the last year. He accumulates the following information about its fixed assets:
| Total asset base | $700,000 |
| Band saws required for maximum capacity | 4 |
| Total band saws available | 7 |
| Average band saw cost | $15,000 |
| Belt sanders required for maximum capacity | 3 |
| Total belt sanders available | 8 |
| Average belt sander cost | $8,000 |
By avoiding the opinions of the production staff and instead relying on a quantitative comparison of capacity levels and available equipment, the CFO has determined that there are three extra band saws and five extra belt sanders, with a combined cost of $85,000. With this information, he calculates the return on operating assets as follows:
Net Income
Assets used to create revenue
=
$230,000 Net Income
$700,000 Total Assets - $85,000 Unproductive Assets
= 37% Return on Operating Assets
Cautions: The specific assets included in the denominator can be subject to a great deal of interpretation, since managers will realize that any assets not included in it will eventually become targets for elimination. Consequently, the list of assets used should be carefully reviewed, preferably with the industrial engineering staff, to ensure that each item has a direct role in the production of revenue.
Similar Ratios
Return on capital employed
Return on equity
Return on net assets