What is Return on Net Assets (RONA)?
Return on net assets (RONA), a measure of financial performance, is an extension of the traditional return on assets ratio. RONA measures how well a company’s fixed assets and net working capital are in 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 the company’s assets are.
Formula for Return on Net Assets
The formula for return on net assets is as follows:
- Net income is a company’s income minus the cost of goods sold, expenses, and taxes for the accounting period.
- Fixed assets are assets purchased for long-term business use. Examples of fixed assets include property, plant, and equipment.
- Net working capital is the difference between the company’s current assets and current liabilities.
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 return on net assets ratio to understand how efficient the company’s fixed assets and net working capital are. Presented below are 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) relate to Fixed Assets. In addition, Tim calculates Net Working Capital to be $148,768 – $92,907 = $55,861. Therefore, the return on net assets calculation is as follows:
Understanding Return on Net Assets
Return on net assets takes into account 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. Although a higher ratio is preferable, it is important to compare the RONA of a company among peer companies. For example, a company with a RONA of 40% may look good by itself but in actuality deemed poor when compared to the industry benchmark of 70%.
On a trended basis, an increasing RONA is desirable as it is an indicator of improving profitability and financial performance of a company. However, one important thing to note is the potential for management to distort RONA. For example, a company may acquire fixed assets to sit on the books to deflate its RONA and 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 before calculating RONA.
Return on net assets is an extension of the traditional return on assets ratio in that it uses fixed assets and net working capital in its calculation as opposed to total assets. The return on net assets ratio is used to determine the efficiency and effectiveness of a company’s assets. A higher RONA is desirable as it implies higher profitability. Lastly, return on net assets should be not interpreted by itself – it should be compared to peer companies or use on a trended basis.
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