Return on net assets (RONA) measures the net profit of a company, divided by net assets. It is the combination of fixed assets and net working capital. As a ratio, RONA helps us evaluate how effective and efficient a company is in using its fixed assets and net working capital to generate income.
RONA is an alternative metric to the more commonly used formula, Return on Assets (ROA). The biggest difference between them is that the ROA uses the total assets instead of net assets. Often, people believe that the return on net assets is the same as the return on equity, which uses equity instead of net assets as the denominator. Both ratios have little to no differences.
Analysts and investors typically use this ratio. By comparing the RONA of multiple companies within the same industry, they can gauge which company can squeeze out the most earnings when compared to each of its own assets. The higher the ratio, the better the company’s management in using its assets in ways that promote growth.
Return on Net Assets Formula
$$RONA = \dfrac{Net\: Income}{Fixed\: Assets + Working\: Capital}$$
To calculate RONA, you will need to measure the net income. You can do this by subtracting expenses, like the cost of making goods, taxes, salaries and utilities, from the total income. You will also need fixed assets. These are tangible or physical assets, like the ones used in production. This could include machinery or real estate. You should also include intangible assets such as copyrights. Fixed assets are part of long term assets and cannot be easily converted into cash.
The final ingredient is net working capital, also known as net current assets. You can find Net working capital by subtracting current liabilities from current assets. Keep in mind that net working capital is different from equity where value could be determined by subtracting total liabilities from total assets. Net working capital comes from the company’s current assets instead of their total assets.
The RONA formula uses a mixture of fixed assets and net working capital. You may notice that we don’t include any liabilities as part of the net assets. Any variable that has the word “net” in front of it usually doesn’t include any liabilities or expenses. This is the same with net assets.
If you do not know the net working capital amount, you can find it by subtracting current liabilities from current assets.
Most analysts use RONA for companies in industries that require more capital. This means that its fixed assets play a major part in the company’s growth. For instance, oil companies mostly operate refinery equipment to convert crude oil into usable commodities. In this case, the RONA formula can be modified into the following:
$$RONA = \dfrac{Plant\: Revenue - Costs}{Fixed\:Assets - Working\: Capital}$$
There’s no need to be confused. In the case of the capital-intensive sector, plant revenue minus costs are more or less the same as net income. Basically, these two can be thought of as total earnings subtracted by any associated costs needed to generate those earnings.
RONA is usually expressed as a percentage. A higher RONA means the company has more earnings per dollar invested in assets. The average value varies from industry to industry, but generally, any number lower than 10% is considered bad.
Return on Net Assets Example
Hakim, an investor, wants to determine if investing for a particular utility company is a good choice. He hires an analyst to do the work. The analyst uses the RONA ratio as one of the many instruments used to evaluate the company’s financial health and profitability.
From the company’s income statement, he can see that the company has a net income of $80,000. The analyst also finds that the company has current assets of $200,000 and current liabilities of $100,000 from the balance sheet. Furthermore, he also obtained the value of fixed assets from the non-current assets category to be $400,000. From this data, can we calculate the RONA for the company?
Let’s break it down to identify the meaning and value of the different variables in this problem.
While we don’t know the amount of working capital, we do know that the current assets equal 200,000, and the current liabilities equal 100,000. We can use our information from the formula section to determine that working capital is 100,000.
$$RONA = \dfrac{80{,}000}{400{,}000 + 100{,}000} = 16\%$$
In this case, the return on net assets would be 0.16 or 16%.
From the result above, we can see that the company is still in a somewhat modest position. Numbers between 15-20% are still typically good. For a utility company that is considered a capital-intensive company, 16% is a decent value so the analyst can put this company as a good candidate for investment if other measuring instruments also show positive results.
Return on Net Assets Analysis
Return on net assets is one of the key instruments often used by investors and analysts alike to evaluate the profit potential of a company. The higher the RONA, the more profitable the company is. With that being said, using only return on net assets is not a wise move. This formula alone cannot accurately portray the general performance of a company.
There’s no exact number to decide if a company has a decent RONA number or not. Different types of companies employ a different approach to funding their assets. For example, capital-intensive companies on average have lower RONA than most technology companies. This is the case since technology companies that do not rely too much on fixed assets, unlike a manufacturer for example. That’s why it’s important to only compare companies with their peers within the same industry.
Another important thing is that RONA sometimes can give a considerably inaccurate view of a company’s financial health. For instance, the value of a company’s fixed assets can be significantly reduced due to accelerated depreciation. Another example might be if there were a shift in the market that resulted in a major loss or gain, but exclusively that period.
These events can stop you from having a correct interpretation of the company’s financial situation. Analysts often take into account these unusual occurrences and adjust their calculations to get a more typical result.
Return on Net Assets Conclusion
- The return on net assets is a ratio of a company’s profitability in relation to its fixed assets and net working capital.
- The formula for return on net assets requires three variables: net income, fixed assets, and net working capital.
- Fixed assets are tangible assets used in production and are long term assets
- Net working capital is the difference between current assets and current liabilities
- The RONA rates vary from industry to industry, but it’s usually considered bad to be lower than 10%.
Return on Net Assets Calculator
You can use the return on net assets calculator below to quickly calculate a company’s profitability in relation to its fixed assets and net working capital by entering the required numbers.