Net Operating Assets: Definition, Formula, Usages, and Limitation

Definition:

Net Operating Assets can be defined as the assets within a business that is related to the operations of the business. It is defined as the difference between the operating assets of the company and the operating liabilities of the company.

Net Operating Assets represent 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 the financial activities of the organization as well.

Formula:

Net Operating Assets basically involve calculating the number of assets and liabilities the business operates with.

It mainly comprises balance sheet restructuring to segregate operating and non-operating assets. However, net operating assets can be calculated in two broader ways:

Operating Approach

Firstly, Net Operating Assets can be calculated using the Operating Approach. As far as the operating approach is concerned, it comprises calculating net operating assets using the following formula:

Net Operating Assets = Operating Assets – Operating Liabilities

However, to calculate net operating assets using this approach, the balance sheet must be reformatted to calculate operating assets and operating liabilities accurately. 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

Financing Approach

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.

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Usages of Net Operating Assets

Net Operating Assets are considered a very useful metric for the organization since it has several advantages for decision-makers.

It is used to compare the business’s net profit with other relevant business models. It shows the net income (or net operating income) that the company has earned compared to its total net operating assets.

Given 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 the company generates as a result of its operations concerning the operating assets that they have.

In the same manner, Net Operating Assets also stand to be a viable basis for calculating other subsequent metrics, including Discounted Cash Flows, Free Cash Flows, and Discounted Operating Earnings. These metrics are considered valuable in estimating the company’s value.

However, the greatest use of Net Operating Assets is perhaps the fact that net operating assets are considered to be resourceful because 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 the 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 of 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 organization’s perspective.

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Similarly, Net Operating Assets are calculated using the book value of the assets and the liabilities mentioned on the balance sheet.

However, this might not represent the true and 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 be a true and fair estimate compared to other organizations. It is only resourceful if it is analyzed over time for a single company only.