Operating Return on Assets (OROA)

What is Operating Return On Assets (OROA)?

Operating Return On Assets (OROA) is one of the most important corporate metrics revealing how effectively a firm uses its assets to generate profit through normal operational processes. This ratio is obtained by dividing the firm’s operating profit by its total assets.

Investors and other stakeholders rely on OROA to evaluate the company’s capability to produce wealth from operational activities.

This is a potent measure of a company’s capacity to convert its principal assets into operating earnings, providing critical information about its operations and financial results.

Compared to the traditional Return on Assets (ROA), OROA focuses on the efficiency of the core operations of a firm. It reveals how well a company leverages its assets to drive profitability within its primary business domain.

A higher OROA signifies that the company is capable of converting its assets into operating profits, indicating strong operational efficiency. Conversely, a lower OROA ratio is not preferred since it indicates the company's inefficiency in utilizing the assets to generate profits.

How to Calculate Operating Return On Assets?

Calculating OROA is a critical financial exercise that sheds light on a company's operational efficiency and profitability concerning its assets used in core business operations.

Here is how we can calculate this ratio:

Operating Return On Assets = Operating Profit / Average Total Assets

First, determine the operating profit, which is the numerator in the OROA formula. It is computed by subtracting the cost of goods sold (COGS) and operating expenses, including selling, general, and administrative expenses, from the company's total revenue.

Operating Profit = Revenue - COGS - Operating Expenses

Next, for the denominator, we will use the average total assets over a specific period, typically the last two years. This step is crucial in smoothing out any significant fluctuations in asset values, offering a more accurate representation of asset utilization.

By following these steps, you can calculate the operating ROA of a company. A higher OROA ratio is generally favorable, indicating more efficient asset utilization by the company.

This calculation is a powerful tool for investors and analysts seeking to assess a company's operational effectiveness and financial performance. It helps them make informed decisions regarding investments and strategic financial planning. 

Example of Operating Return On Assets

Now that we know how to calculate the OROA ratio, let us see how we can evaluate a company’s operational efficiency and profitability using data from its annual report.

So, let us go ahead and do the calculations for the company Microsoft. We have extracted the following financial data from the company’s annual report for 2023.

Please note that we have included only those aspects of financial reports needed to compute the operating return on assets as far as the company is concerned.

Partial Income Statement

(In millions USD, except per share amounts)

Partial Balance Sheet

(In millions USD, except per share amounts)

To calculate OROA, we need to determine the operating profit for 2023. From the above financial data:

Operating Profit for 2023 = $88,523

Now, for the average total assets, we will take the mean of the total assets for 2023 and 2022.

So, the average can be calculated as

Average Total Assets = ($4,11,976 + $3,64,840) / 2 = $3,88,408

Therefore, the OROA can be calculated as

Operating Return on Assets for 2023 = Operating Profit for 2023 / Average Total Assets

= $88,523 / $3,88,408

= 0.23

Thus, this can be translated as the firm producing $0.23 from its core business from each dollar worth of the assets utilized by it.

This leads us to estimate the measure of this ratio for comparable companies in the same market to find out firms that have high operating efficiency.

Additionally, we can also do a historical comparison of the ratio for some particular company and sense how the business operations of the company have been performing in previous years.

Benefits of Operating Return On Assets

The use of Operating Return on Assets (OROA) offers several benefits in financial analysis, allowing analysts and investors to gain a clearer picture of a company's operational performance and asset utilization.

Let's break down the advantages of utilizing OROA.

Focus on Core Operations 

OROA isolates a company's core business operations by using operating profit in the calculation. It excludes non-operational aspects, such as proceeds from asset sales, interest income, interest expense, taxes, and investment returns.

This provides a more precise view of how efficiently a company generates income from its primary activities.

Elimination of Non-Operational Distortions 

OROA disregards non-operational items that can distort financial metrics. For example, if a company records a one-time significant profit from the sale of assets, it can artificially inflate net income for that year.

OROA prevents such distortions, offering a more stable and reliable performance measure.

Consistency in Analysis 

OROA provides consistency in financial analysis by focusing solely on the core business. This approach ensures that variations in non-operational factors, such as tax rates and interest, do not skew financial comparisons across companies and industries.

Enhanced Comparability Across Countries

OROA makes comparing the performance of companies operating in different tax environments easier. Tax rates vary widely between countries, and using net income in traditional metrics like ROA can lead to misleading comparisons.

OROA helps in creating more meaningful and comparable performance benchmarks.

Improved Financial Forecasting

By concentrating on operating profit, OROA aids in creating more accurate financial forecasts. It allows analysts to predict future performance without the noise of exceptional or non-recurring items, leading to more reliable projections.

Conclusion

The Operating Return on Assets (OROA) is a valuable tool for investors and analysts. It focuses on a company's core operating income relative to its assets. It provides a clear picture of how efficiently a company uses its assets to generate profits from its daily operations.

OROA acts as a filter, eliminating non-operational elements and offering insights into a company's fundamental performance.

This ratio's significance lies in its ability to uncover the true earnings potential of a business without the noise of one-time events, interest income, or tax variations. It's a more precise measure of profitability tied directly to a company's primary activities.

Considering this, we have learned about the significance of OROA and how we can calculate this metric from the financial data of the company. 

Researched and authored by Sauryan Pandey | LinkedIn

Reviewed and edited by Parul Gupta | LinkedIn

Free Resources

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