Page 690 - Accounting Principles (A Business Perspective)

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Rate of return on operating assets The best measure of earnings performance without regard to the
sources of assets is the relationship of net operating income to operating assets, the rate of return on operating
assets. This ratio shows the earning power of the company as a bundle of assets. By disregarding both

nonoperating assets and nonoperating income elements, the rate of return on operating assets measures the
profitability of the company in carrying out its primary business functions. We can break the ratio down into two
elements—the operating margin and the turnover of operating assets.
Operating margin reflects the percentage of each dollar of net sales that becomes net operating income. Net
operating income excludes nonoperating income elements such as extraordinary items, cumulative effect on
prior years of changes in accounting principle, losses or gains from discontinued operations, interest revenue, and
interest expense. Another name for net operating income is "income before interest and taxes" (IBIT). The

formula for operating margin is:
Net operatingincome
Operating margin=
Net sales
Turnover of operating assets shows the amount of sales dollars generated for each dollar invested in
operating assets. Operating assets are all assets actively used in producing operating revenues. Typically, we use

year-end operating assets, even though in theory an average would be better. Nonoperating assets are owned by
a company but not used in producing operating revenues, such as land held for future use, a factory building rented
to another company, and long-term bond investments. Analysts do not use these nonoperating assets in evaluating
earnings performance. Nor do they use total assets that include nonoperating assets not contributing to the
generation of sales. The formula for the turnover of operating assets is:
Netsales
Turnover of operatingassets=
Operatingassets
The rate of return on operating assets of a company is equal to its operating margin multiplied by turnover of
operating assets. The more a company earns per dollar of sales and the more sales it makes per dollar invested in
operating assets, the higher is the return per dollar invested. To find the rate of return on operating assets, use the
following formulas:
Operating margin×Turnover of operatingassets=Rate of return onoperatingassets
or
Net operatingincome Netsales
Rate of return onoperatingassets= ×
Netsales Operatingassets
Because net sales appears in both ratios (once as a numerator and once as a denominator), we can cancel it out,
and the formula for rate of return on operating assets becomes:
Net operatingincome
Rate of return onoperatingassets=
Operatingassets
For analytical purposes, the formula should remain in the form that shows margin and turnover separately,
since it provides more information.
The rates of return on operating assets for Synotech for 2010 and 2009 are:

(USD millions) 2010 2009 Amount of increase
or (decrease)
Net operating income (a)* $ 1,382.4 $ 682.7 $699.7
Net sales (b) $10,498.8 $10,029.8 $469.0
Operating assets (c) † $9,481.8 $ 9,170.8 $311.0
Operating margin (a/b) 13.17% 6.81%

Accounting Principles: A Business Perspective 691 A Global Text