Net Operating Assets can be defined as the assets within a business that is related to the operations of the business. It is simply defined as the difference between the operating assets of the company, and the operating liabilities of the company.
Net Operating Assets are basically the representation of how many assets, and liabilities the business has at a given point in time, that are relevant to the operating activities of the business.
It is important to identify net operating assets, because it discretely segregates the amount that the business has invested in its core operating activities, versus its other activities, which include financial activities of the organization as well.
Net Operating Assets basically involves calculating the number of assets and liabilities that are the business is operating with.
It mainly comprises balance sheet restructuring in order to segregate the operating assets from the non-operating assets. However, net operating assets can be calculated in two broader ways:
Firstly, Net Operating Assets can be calculated using the Operating Approach. As far as the operating approach is concerned, it comprises of calculating net operating assets using the following formula:
Net Operating Assets = Operating Assets – Operating Liabilities
However, in order to calculate net operating assets using this approach, the balance sheet must be reformatted in order to accurately calculate operating assets and operating liabilities in an accurate manner. In this regard, operating assets are calculated using the following formula:
Operating Assets = Total Assets – Excess Cash (and Cash Equivalents) – Financial Assets (including the investments carried out by the company)
In the same manner, operating liabilities are also calculated using the following formula:
Operating Liabilities = Accounts Payable + Deferred Operating Expenses (Accruals) + Deferred Taxes on Operating Income + Reserves maintained for Operating Expenses
Alternatively, it can be seen that the financing approach can also be used to calculate the Net Operating Assets. Net Operating Assets calculated using the financing approach have the following formula:
Net Operating Assets = Equity + Short-term and Long-Term Non-Operating Debts (Non-Current Operating Assets) – Financial Assets and investments – Excess cash and cash equivalents
Using the financing approach, it can be seen that the amount of net operating assets is calculated as the net amount of interest-bearing debts.
Usages of Net Operating Assets
Net Operating Assets is considered to be a very useful metric for the organization since it has a number of advantages for the decision-makers of the company.
It is used for the purposes of comparing the net profit of the business with other relevant business models. It shows the net income (or net operating income) that the company has earned, in comparison to the total net operating assets it has.
Given the fact that it mainly ignores the financial benefits that are extrapolated as a result of interest-bearing expenses, the impact of leverage is minimized from the returns.
Hence, this represents the core profits that are generated by the company as a result of their operations, with respect to the operating assets that they have.
In the same manner, Net Operating Assets also stands to be a very viable basis to calculate other subsequent metrics, including Discounted Cash Flows, Free Cash Flows as well as Discounted Operating Earnings. These metrics are considered valuable in terms of estimating the value of the company.
However, the greatest use of Net Operating Assets is perhaps the fact that net operating assets are considered to be resourceful is because of the fact it helps to show the operating threshold of the company, in terms of the investment it has made in the existing operations within the company.
Limitations of Net Operating Assets
Where on one hand, net operating assets are representative of the extent to which operations are properly managed, yet it can be seen that the fact that they do not include any analysis pertaining to the financial leverage of the organization.
For example, an organization might have higher net operating assets, but its financial asset management might not be that efficient. In this case, relying solely on this metric might be risky from the perspective of the organization.
In the same manner, Net Operating Assets are calculated using the book value of the assets and the liabilities that are mentioned on the balance sheet.
However, this might not be representative of the true and the fair value of the net operating assets, since these figures in the balance sheet might not be aligned with the existing market values for these respective assets and liabilities.
Therefore, it might not a true and fair estimate if used in comparison with other organizations. It is only resourceful if it is analyzed over a course of time, for a single company only.