Operating assets are the resources that run a business. These are the assets employed in an operational capacity to generate revenue for the business.
Net operating assets mean all resources applied in operations net of operational obligations. Importantly, operating assets exclude financial assets and financial obligations of the business.
Let us discuss net operating assets, the calculation method, and their measurement method.
What are Net Operating Assets (NOA)?
Net operating assets of a business are the net of assets used in operations minus the liabilities incurred through operations.
Simply, net operating assets are the net difference between the operating assets and operating liabilities. It is a useful metric to measure the operational performance of a business.
Operating assets relate to the operational efficiency of a business. These are the resources a company implies in operations to generate revenue.
Net operating assets would mean deducting operating liabilities from the operating resources. In other words, it will be the net effect of operating resources and operating expenses.
Let us briefly discuss operating assets and operating liabilities to fully understand net operating assets.
Operating Assets
These are the assets used to support the operational activities of a business. These assets can be in the form of cash, equipment, or intangible resources.
An important distinction to note here is that operating assets are mostly current assets. In contrast to the long-term or fixed assets, these assets are regularly used in the day-to-day operations of the business.
Types of Operating assets
Operating assets can come in different forms. However, the primary distinction should come through the usage of these assets in operational activities.
Current Assets
These assets include cash, accounts receivable, inventory, and other assets that are directly used in the operational activities of a business.
Importantly, only the operating cash balance should be counted as an operating asset. Long-term cash deposits that earn interest should be categorized as financial assets.
Pre-Paid Expenses
These are operational pre-paid expenses that a business pays in advance. Examples of these assets include advance trade payments, advance utilities, or inventory payments.
Tangible and Intangible Operating Assets
Another approach to categorize operating assets is to divide them into the form of tangible or intangible assets.
Tangible assets will include inventory, purchases, equipment, and machinery used in operational activities. While intangible assets will include cash balance, accounts receivable, and so on.
Operating Liabilities
Operating liabilities result from the operational activities of a business. These liabilities include accounts payable, taxes, and accrued expenses.
Again, it is important to differentiate between the operational and financial liabilities. For instance, interest paid on a short-term bank loan will be considered a financial liability rather than an operational liability.
Types of Operating Liabilities
We can categorize operating liabilities in the same way as operating assets.
Some common types of operating liabilities will include:
- Current liabilities such as accounts payable, utilities, accrued expenses, etc.
- Pre-paid income such as advance payments of sales, proceeds from current asset sales, etc.
- Tangible and intangible operating liabilities such as wages, estimated taxes, and other accrued expenses.
How to Calculate Net Operating Assets?
We can take a step-by-step approach to calculate the net operating assets of a business.
Step 01: Identify All Operating Assets of the Firm
The first step is to calculate the total operating assets of the firms. It is important to differentiate between the operating and financial assets at this stage. For instance, cash can be included in operating as well as financial assets.
Some common types of operating assets include:
- Cash and Cash Equivalents; primarily used for operations.
- Accounts receivable for the current period.
- Pre-Paid expenses
- Tangible and intangible operating assets such as inventory, machinery, equipment, and so on.
Step 02: Identify All Operating Liabilities of the Firm
The next step is to identify all operating liabilities of the firm. Again, it is important to consider only the operating liabilities of the business at this stage.
Some common examples of operating liabilities include:
- Accounts payable
- Accrued expenses
- Salaries and wages
- Estimated monthly taxes
Step 03: Put in the Values
The third step is to simply put in the net values of both items calculated above. By step, you should have total operating assets and total operating liabilities.
Step 04: Calculate Net Operating Assets Using the Formula
The final step is to calculate the net operating assets using the following formula:
Net Operating Assets = Total Operating Assets – Total Operating Liabilities
Alternative Approach
We can take an alternative approach to calculate net operating assets as well.
The alternative formula is:
Net operating Assets = The total assets of a company – All liabilities – All financial assets + All financial liabilities
This alternative approach takes the total assets of a company. Then, you deduct the total liabilities and only the financial assets of the company.
Next, you’ll add back the financial liabilities to the equation. The end result will give you the net operating assets of a company. Effectively, this formula also calculates the same figure of net operating assets.
Example
Let us consider a simple working example to calculate the NOA figure.
Suppose the following data is available for a company ABC co.
Total Assets = $ 1,500,000 Total Liabilities = 1,100,000
Financial Assets = $ 650,000 Financial Liabilities = $ 430,000
Using the formula:
Net operating Assets = The total assets of a company – All liabilities – All financial assets + All financial liabilities
Net Operating Assets = 1,500,000 – 1,100,000 – 650,000 + 430,000
Therefore, Net Operating Assets = $ 180,000
How to Measure Net Operating Assets?
The profits of a company are measured in several ways. One way is to categorize returns from operating and financing activities. The main source of income for any business comes through its operations that generate sales revenue. Thus, it is wise to calculate the return on operating assets.
The net operating asset is an operational efficiency measure. It is a useful indicator of the operating resources of a business. Thus, it is wise to compare the profits from operations and net operating assets.
Return on net operating assets (RNOA) is a useful measure to appraise the efficient utilization of net operating assets.
The formula for RNOA is:
Return on Net Operating Assets (RNOA) = Profit After Tax / Net Operating Assets
Net operating assets of a firm can be calculated in one of the two ways discussed above. The profit after tax (PAT) figure is usually a readily available figure on the income statement of the business.
Net Operating Assets and Net Profit
Net profit is the ultimate profit figure that most stakeholders like to see from a business. It is the bottom line of the business operations for investors and managers alike.
A common approach used in net profit and NOA calculations is to analyze the operational efficiency of the business. Both of these figures assess the resources implied by a business to generate revenues.
Net profit starts by taking total revenues minus COGS. Then, you deduct the operating expenses of the business including taxes and interest. The resulting figure is the net profit of the company.
Net operating assets can also be calculated in a similar way as discussed above. NOA excludes financial assets and financial liabilities from the calculations. The resulting figure is the return generated by operating resources net of operating liabilities.
Thus, both these figures concentrate on similar metrics. Hence, these two metrics can be used in conjunction when analyzing the performance of a business.
Concluding Remarks
The NOA measure separates the operating and financial income of a business. Thus, it helps a business to analyze the main source of revenue and its efficiency.
NOA can then be analyzed further using performance analysis metrics such as RNOA. The RNOA ratio further provides an analytical metric that links the net profits with the net operating assets.
Since the calculation of NOA excludes financial assets and liabilities, it will not change with the leverage level of the business. In other words, the metric does not rely on resources provided through leverage (debt financing). Similarly, it will not be affected by the level of financial liabilities as well.
