An extension of the traditional return on assets ratio
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The return on net assets (RONA) ratio, a measure of financial performance, is an alternative metric to the traditional return on assets ratio. RONA measures how well a company’s fixed assets and net working capital perform in terms of generating net income.
Return on net assets is commonly used for capital-intensive companies and is an important ratio looked at by investors and analysts to determine how effective and efficient a company is at generating a profitable return on its net assets.
The formula for calculating RONA is as follows:
Net income is a company’s income minus the cost of goods sold, expenses, and taxes for the accounting period.
For the purposes of this analysis, net working capital is simply the difference between the company’s current assets and current liabilities.
The return on net assets (RONA) ratio is an alternative metric to the traditional return on assets ratio. RONA measures how well a company’s fixed assets and net working capital perform in terms of generating net income.
There is no “ideal” return on net assets ratio number, but a higher ratio is preferable. It is important to compare the RONA of a company to peer companies.
On a trended basis, an increasing RONA is desirable, as it is an indicator of improving profitability and financial efficiency.
Example of Return on Net Assets
Tim is an equity research analyst conducting an analysis of ABC Company. He would like to determine the company’s most recent RONA ratio to understand how efficient the company’s use of its fixed assets and net working capital is. Presented below is financial information pertaining to the company.
Through the income statement, Tim determines the company’s net income to be $81,323. On the company’s balance sheet, he determines that only property, plant, and equipment ($41,304) comprise the company’s fixed assets. In addition, Tim calculates Net Working Capital to be $148,768 – $92,907 = $55,861. Therefore, the RONA calculation is as follows:
Understanding Return on Net Assets
Return on net assets is used to assess the financial performance of a company in relation to its fixed assets and net working capital. Similar to the return on assets ratio, a higher RONA indicates a higher level of profitability.
There is no “ideal” return on net assets ratio number, but a higher ratio is preferable. It is important to compare the RONA of a company to peer companies. For example, a company with a RONA of 40% may look good in isolation, but that figure may actually appear poor when compared to an industry benchmark of 70%.
On a trended basis, an increasing RONA is desirable, as it is an indicator of improving profitability and financial efficiency. One important thing to note is the potential for management to distort its RONA. For example, a company may acquire fixed assets to sit on the books to deflate its RONA and then subsequently sell the fixed assets in later periods to increase their RONA. Therefore, it is important to understand the nature of the company’s fixed assets when calculating RONA.
Return on net assets is a variation of the traditional return on assets ratio that uses fixed assets and net working capital in its calculation as opposed to total assets. The RONA ratio is used to determine the efficiency and effectiveness of a company’s use of its assets. A higher RONA is desirable as it implies higher profitability. Lastly, as with any financial metric, it should be not interpreted by itself – it should be compared to peer companies or used on a trended basis.
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