What are Net Operating Assets?
Net operating assets (NOA) is a measurement of the net worth of a company. It’s the value of the company’s assets minus liabilities, including stockholders’ equity and debt. In other words, net operating assets measure what’s left over after subtracting all debts and obligations from all that remains.
The general accepted principles should be followed when calculating the net operating assets to avoid putting the business/corporation in a financial crisis. As a student calculating the net operating assets may be a bit challenging. However cost accounting homework help can help you with your accounting homework.
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Assets are resources that are owned and controlled by either corporations, government or individuals. The purpose of owning assets is to create a positive economic benefit. Types of assets include:
- Current Assets
- Non-current Assets
- Physical Assets
- Intangible Assets
- Operating Assets
- Non-operating Assets
Knowing what all these types of assets are is important in accounting because they can be used to determine the net worth of a business. Examples of assets include: cash, account receivable, inventory, building, machinery, equipment, patents etc.
How to Calculate Net Operating Assets
To calculate the net operating assets of a company, we can use two simple the formulas:
- Net Operating Assets = Operating Assets – Operating Liabilities
Where;
Operating Assets = Cash + total accounts receivable + inventory + prepaid assets + fixed assets + tangible assets + intangible assets
Operating Liabilities = Accounts payable + total operating expenses
OR
2. Net Operating Assets = Total Assets – Financing Assets – Total Liabilities + Financing Liabilities.
The steps to follow when calculating the net operating assets using the second formula:
- Determine the sum of all assets
- Determine the sum of all cash and investment that generate revenue
- Determine the sum of all liabilities
- Determine the sum of all liabilities that generate expenses.
Example 1
Wallace wants to calculate the net operating assets for his company. The entries to his company are as follows;
- Total assets = $750,000
- Total liabilities = $250,000
- Cash = $50,000
- Inventory = $25,000
- Accounts payable = $15,000
- Long-term bank loan = $20,000
To calculate Wallace company net operating assets this is what we do; (assuming we use the second formula)
- Total assets = $750,000
- Total liabilities = $250,000
- Financing assets (cash) = $50,000
- Financing liabilities (Long-term bank loan) = $20,000
=Total assets – financing assets – total liabilities + financing liabilities
$750,000 – $50,000 (cash) – $250,000 + $20,000 (long-term bank loan)
NOA= $470,000
Example 2
Y has his entries as
- Total asset value of $5,000,000
- Total liabilities value of $2,000,000,
- Marketable securities and cash value of $150,000
- Debt value of $350,000
=Total assets – financing assets – total liabilities + financing liabilities
$5,000,000- $150,000 – $2,000,000 + $350,000
= $3,200,000
Y has a net operating assets of $3,200,000
Why are Net Operating Assets Useful?
As a fund accounting student it’s important to be aware of the uses of knowing the worth of net operating assets. Some of the uses include:
1. Measurement of a company’s financial health
Net operating assets measure a company’s financial health. If the net operating assets are positive, it means that the business is profitable. If negative, it means that the company is not earning enough money to pay off the debts and obligations.
2. Company’s ability to pay bebts
By calculating net operating assets, a business owner can determine how much money is available to be used in paying debts.
3. Net worth
By calculating net operating assets, it will show the true value of a company’s assets and liabilities. If a company is in debt for example, it may not be safe to assume that all of its assets are worth the same amount. In this case, net operating assets is useful because it would show how much the company can lose in one year due to its debts.
What Is Return On Net Operating Assets?
Return on net operating assets is the amount of money earned from net operating assets. This is the amount of money that can be earned from the net operating assets when the business owner uses it to make a profit.
How to Improve the Return on Net Operating Assets
1. Get a high net operating income
To get a high return on net operating assets, the business owner will have to get a high net operating income. A high net operating income means that the company is earning a lot of money and can use all of it to make a profit.
2. Create more profitable business operations
To create more profitable business operations, the business owner will have to look for ways to make money through each of their business operations. One way to do this is by finding ways to make money from the existing business operations.
3. Invest in new revenue-producing operations
To increase the value of its net operating assets, a business owner will have to invest in new revenue-producing operations. This means that the company will have to hire people and purchase new equipment that could generate more profit from the net operating assets.
How to Calculate Return on Net Operating Assets (RNOA)
The formula to calculate return on net operating assets is:
Net income ÷ Assets used to create revenue
Return on Net Operating Assets (RNOA) = Net Income ÷ Net Operating Assets
Example 1
Newface Brewing Company has acquired assets that are no longer needed for the continuation of his company. The manager gathers information to develop a document on returns on net operating assets with an intent of discovering the item to dispose of. They get the following information:
- Net income for the past year was $600,000
- The gross amount of assets on the cellar tanks is $7,000,000
- There are three excess boilers, recorded at $75,000 in total
- There are two excess storage tanks, recorded at $45,000 in total
- There is an extra ancillary equipment, recorded at $500,000
The return on assets in this case will be:
Net income ÷ Net operating assets
Where;
Net income = $600,000
Net Operating Assets = (gross assets {$7,000,000} – unproductive assets {$620,000}) = $6380000
RNOA = $600,000 ÷ $6,380,000
RNOA = 9.4%
Example 2
Company B produced;
- Net income of $ 130,000 for the 2020 financial year.
- Total assets were $ 1,500,000
- Marketable securities of $ 250,000
- Total liabilities of $ 1,000,000
- Financial liabilities of $300,000.
First we calculate the net operating assets of company B:
Net Operating Assets = Total assets – financing assets – total liabilities + financing liabilities
NOA = $ 1,500,000 – $ 250,000 – $ 1,000,000 + 300,000
NOA= $ 550,000
We already have NOA. Now we proceed and calculate RNOA
Return on Net Operating Assets = Net Income / Net Operating Assets
Return on Net Operating Assets = 130,000 ÷ 550,000
Therefore, RNOA = 23.63 %
Interpretation
The RNOA figure provides useful information of a company’s ability to generate profits from equity resources. It distinguishes the financial and investment income from the operating income.
The operating income of a company remains the main source of profits through sales. Hence the net operating assets provide the efficient use of assets employed in the business.
Net Operating Assets Turnover Ratio
It is also known as the current assets turnover ratio. It shows the number of times operating assets are turned over in the year.
How To Calculate Net Operating Assets Turnover Ratio
Net operating assets turnover ratio formula;
Operating asset turnover ratio = sales ÷ average operating assets
Example
The following data were obtained from Joachim Traders:
- Current assets at the start of 2019: $1,500,000
- Current assets at the end of 2019: $1,350,000
- Net sales made in 2019: $3,500,000
Required: Calculate the net operating asset turnover ratio of Joachim traders for the year 2019.
Solution
Current turnover ratio = Sales ÷ average total assets
Average total assets = ($1,500,000 + $1,350,000)/2
Average total assets = $1,425,000
Net operating assets turnover ratio = $3,500,000 ÷ $1,425,000
= 2.46
The net operating assets turnover ratio of Joachim Traders is 2.5. This means that each dollar Joachim invested in current assets generated $2.5 in net sales.
In case Joachim wants to come up with an appropriate decision of how efficiently current assets were used in 2019, he must compare his net operating assets turnover ratio with other traders.
How To Improve The Asset Turnover Ratio
Asset turnover ratio is a measure of the effectiveness of a company’s operations. It represents the ratio of net income to average assets. The higher this ratio is, the better a business is in maximizing its operating assets.
To improve the asset turnover ratio you should do the following:
1. Increasing Revenue
One way to improve the asset turnover ratio is by increasing the revenue. The business owner will have to find ways to generate more income by selling more products or services. In order to do this, the company has to look for ways to make their existing products and services more profitable.
2. Selling Assets
The business owner will also have to sell some of the company’s assets. This means that the company will have to sell some of its machinery and equipment, building and land, etc. Since these assets are already being used by the company, they have lower net operating values compared with other assets.
3. Leasing Assets
Another way to improve the asset turnover ratio is by leasing assets. Leasing assets allows the company to sell some of its assets and use the cash from selling the assets in making more investments.
Other ways of improving the asset turnover ratio include: improving inventory management, improving efficiency, computerizing inventory and order systems, etc. However, as much as businesses wants to improve the asset turnover ratio, they should ensure they maintain an ethical business environment.
How Does Net Operating Assets Affect the Return on Equity?
In order to know whether a company’s operations are profitable, the business owner will have to know how much profit the company has earned from its net operating assets. The higher the return on equity from net operating assets, the more profit the company is earning from its operations.
To improve the return on equity from net operating assets, there must be improvement in:
- Net Operating Income
- Asset Turnover Ratio
- Gross Profit Ratio
Why is Interest Expense Ignored When Computing Return on Net Operating Assets?
Interest expense is not considered when computing the return on net operating assets. Interest expense is recorded in operating expenses and therefore, it affects the net operating income of a business. However, interest expense is considered as a non-operating portion of expenditure. This means that interest expenses are not related to the company’s operations.
Therefore, interest expense will not affect the net operating assets value and therefore will not affect the return on net operating assets value.
The return on net operating assets will increase if the company’s net operating income increases. This can be done by improving the net operating income, increasing asset turnover ratio and by selling off some of its assets.
The higher the asset turnover ratio and the lower the interest expense, the higher is the return of a business on its net operating assets.
The higher return of a company on its net operating assets means that it can earn more profit from its operations through doing so.
Learn More
Thank you for reading CFI’s guide to Net Operating Assets. To learn more about assets and financial analysis, see the following CFI resources:
