The return on net assets measure compares net profits to net assets to see how well a company is able to utilize its asset base to create profits. 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)
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
There are a few issues to be aware of when using this ratio:
- Accelerated deprecation. You can also use a fixed asset valuation that is net of depreciation, but the type of depreciation calculation used can skew the net asset amount significantly, since some accelerated depreciation methods can eliminate as much as 40% of an asset’s value in the first full year of usage.
- Unusual items. If a significant proportion of net income is comprised of income or losses due to unusual items that have nothing to do with ongoing revenue creation, the impact of these items should be eliminated from net income for the purposes of the calculation.
- Intangibles. Consider eliminating intangible assets from the asset base, especially if these are "manufactured" assets derived from an acquisition transaction.
The return on net assets is also known as RONA and return on assets.