What it means
RONA looks at how well management uses the physical and operating resources of the business. It is especially useful in industries with heavy assets, such as manufacturing, utilities and transport.
By comparing profit with the net assets, it shows how much each dollar of equipment, property and working capital earns. The net assets in the denominator are fixed assets plus net working capital.
Fixed assets are long-lasting items like machinery and buildings, while net working capital is current assets minus current liabilities. Excluding cash and non-operating investments, as many analysts do, keeps the focus on operating assets.
Different analysts define the numerator in slightly different ways. Some use net income, while others prefer operating profit after tax, because it removes the effect of how the company is financed.
Whichever one is chosen, it should be used consistently when comparing periods or companies. RONA is closely related to return on capital employed (ROCE) and return on invested capital (ROIC).
All three compare profit with the resources used, but they differ in what is counted as capital. RONA tends to be the simplest to calculate from a balance sheet and an income statement.
Managers use RONA to compare plants, divisions and product lines, and to judge whether new investment is worth it. If a division earns a RONA of 6% while the company cost of capital is 9%, it is destroying value, and management should ask why.
Boards also use it to set performance targets for operating managers. The main nuance is that RONA can be distorted by old assets.
A factory with heavily depreciated equipment will show a low asset base and therefore a high RONA, even though replacing that equipment would cost far more. For this reason, RONA should be read alongside the age and condition of the assets.
In practice
Real-world examples.
Example
A plant manager compares two factories in the same group. Factory A earns $900,000 on net assets of $6,000,000, a RONA of 15%, while Factory B earns $500,000 on net assets of $8,000,000, a RONA of 6.25%. The board asks Factory B to explain its weaker returns.
Example
A utility company wants to see whether a new pipeline project is worth the money. It forecasts the extra net income and divides it by the extra net assets the project needs. The project only goes ahead if the RONA exceeds the company's cost of capital.
Example
A retailer reduces its inventory by $400,000 through better stock control. Net working capital falls, so RONA rises even though profit has not changed. The finance director highlights this as a gain in efficiency.
Formula
Calculation
RONA = Net income / (Fixed assets + Net working capital)
Suppose a bakery chain reports net income of $600,000, fixed assets of $3,000,000 and net working capital of $1,000,000. Net assets = 3,000,000 + 1,000,000 = $4,000,000. RONA = 600,000 / 4,000,000 = 0.15, or 15%. This means each dollar of net assets produced 15 cents of profit during the year.Case study
Seen in the real world.
Ironbridge Packaging is an illustrative, fictional manufacturer with two product lines, cartons and film. The group reported net income of $2,400,000 on net assets of $16,000,000, a RONA of 15%.
When the finance team split the figures, cartons earned $2,000,000 on $8,000,000 of net assets, a RONA of 25%. Film earned only $400,000 on $8,000,000, a RONA of 5%, which was well below the company's cost of capital.
Management decided to sell half of the film equipment and use the proceeds to grow cartons. The illustrative lesson is that a single group RONA can hide a strong business and a weak one under the same average. After the change, the finance team planned to report RONA by product line every quarter so the board could see the gap early. They also agreed to show the age of the equipment beside each figure, so that nobody mistook old assets for efficiency.
Watch out
Common mistakes.
- Comparing RONA across companies without checking that they define net assets and income in the same way.
- Reading a high RONA as proof of efficiency when it may simply reflect old, heavily depreciated assets.
- Using year-end net assets only, when an average of opening and closing balances gives a fairer picture for a growing business.
Questions
People also ask.
What is a good RONA?
It depends on the industry, but it should at least exceed the company's cost of capital, otherwise the business is not earning its keep.
How is RONA different from ROA?
Return on assets uses total assets, while RONA uses only fixed assets and net working capital, which strips out non-operating items and liabilities.
Can RONA be improved without raising profit?
Yes, by reducing the net assets needed, for example through tighter inventory control or by selling unused equipment.
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