Question

What are the components of RNOA? Discuss how they link to each other.

Answer 1

RNOA is Return on Net Operating Assets which is the return a company is earning on its Net Operating Assets which are generating most of its revenue, Operating Revenue. It shows how efficiently a company is employing its Operating assets.

Net Operating Assets are the Operating assets after netting off Operating Liabilities. Operating Assets comprises Receivables, inventories, prepaid expenses, buildings, plants and equipments, and capital leased assets, whereas, Operating Liabilities include Payables, accrued liabilities like employee benefits (pensions) and tax liabilities.

Net Operating Assets = Operating Assets - Operating Liabilities

RNOA = Net Operating Profit After Tax / Average Net Operating Assets

Net Operating Profit After Tax is the after-tax Operating Profit, that is, Earning Before Interest & Tax, which is the actual earning to the company or firm. Deduction after Operating Income, leads to earnings which are for company's debt-holders and shareholders. Therefore, NOPAT is what signifies an equivalent earning which can be used against company's Net Operating Assets.

If we break RNOA into two parts, we can do that by dividing and multiplying it by Sales

RNOA = NOPAT / Sales + Sales / Average Net Operating Assets

NOPAT / Sales = Net Operating Profit Margin

Sales / Average Net Operating Assets = Net Operating Asset Turnover Ratio

Net Operating Profit Margin and Net Operating Asset Turnover Ratio are the two components of RNOA

Net Operating Profit Margin finds operating profitability with respect to sales which is a measure of company's operating efficiency in cost control.

Net Operating Asset Turnover Ratio finds the number of times by which Company has used its net operating assets for generating Sales which measures company's efficiency in utilizing its assets and converting the usage into Sales.

In terms of RNOA, managers have to make a trade-off between NOPM and NOAT. Companies can increase RNOA by either increasing their NOPM through cost control or increasing their NOAT through increased Asset utilization for Sales generation. However, many experts advise to focus on both.

Both NOPM and NOAT measure a company's efficiency.

Since NOPAT is before Interest deductions and Net Operating Assets doesn't include financing decisions like Debt and Equity unlike ROE, hence, RNOA is a better measure for measuring operational efficiency.