RNOA: What It Is, And Why I Love This Profitability Measure

There are thousands of financial metrics and ratios for looking at and understanding your business, but few are as valuable as RNOA. This has been my go to metric for understanding the profitability of small businesses.

I have used it in acquisitions and in operations. I've used it to derive current sources of profitability as well as develop new ones. 

RNOA is one of the most important concepts and metrics to understand in business.


RNOA is Return on Net Operating Assets. 

Every business has both financial and operating assets and liabilities. When we isolate these from each other, we get what is called an unlevered view of the businesses. That is, what the business does without financial leverage. This is incredibly important because it shows you

  • What the business can do without leverage
  • What the volatility of those returns are
  • What you can safely achieve with leverage
  • What risk the business can hold

Let's look at how to calculate RNOA specifically so we can see how to use it and what it means for operating a small business.

RNOA Breakdown

Net Operating Assets are your operational base. They are the "size" of the base you have with which to create a return. The ability to generate 1 million dollars from a 10 million dollar business is different than from a 2 million dollar business. Looking at return in terms of your Net Operating Assets, or NOA gives you the ability to understand how well you are doing compared to how you have done

  • in the past compared to when you were a different size
  • compared to others in the industry or market

Looking at income or return in terms of size levels the playing field.

In addition to size, it's solely the operational size. To look at the operations without debt, we take a traditional balance sheet and separate the assets and liabilities into Operational Assets & Liabilities, and Financial Assets and Liabilities. We then group these by Operational and Financial rather than Assets and Liabilities. When we net out the Operational portion (Operating Assets - Operating Liabilities) we get Net Operating Assets!


The return component in this case is Operating Income. This is income net of financial impact. The exact calculation is a bit more complicated than just NOPAT (EBIT x Tax Rate) because you need to do a tax allocation and include some comprehensive income, but you can estimate it using NOPAT, or Net Operating Profit After Tax

What we end up with is:

Unlevered Earnings Purely From Operations / Net Operating Base 


Operating Income / Net Operating Assets.

So why is this important?

RNOA Explanation

RNOA is a look at the profitability of a firm without leverage, focused solely on the operations. It shows the impact that decisions you are making have on the growth and profitability of the business. By stripping away leverage

  • you get a clearer look at how well your business is doing
  • you get a less volatile number with which to look ahead
  • you get a clean operational number you can breakdown further, understanding the sources of that profitability

The Portfolio Example 

One of the best ways that I have found to describe RNOA is in terms of a personal portfolio.

Let's say you have $100,000 in your bank account. You can consistently return 8% in the markets given a particular strategy you employ. 

At the end of the year, you would have $108,000 in your account. 

In this case,

  • $100,000 is your NOA... its the base you have to generate your return.
  • 8% is your RNOA. It's your return given that base.

If you wanted to generate a greater return with the same capital base, you could borrow money. Let's say you borrow another $100,000 at 3%.

  • You would then make 8% on $200,000, giving you a gross return of $16,000.
  • Then you would pay $3,000 back to the bank along with the borrowed $100,000 leaving you an account of $113,000 and a net return of $13,000.

The 13% is the levered return. Your strategy and portfolio still only returned 8%, you just borrowed more to increase your net return. When analyzing a business, the financial leverage can raise or lower your net return quite a bit, lowering your ability to clearly see how well (or poorly) the operation is doing. 

Looking at the unlevered return is a way to clearly see the profitability of the company, and measure across time periods and companies to understand trends and health.

Total Return System

RNOA is just one component of the Total Return System in a business. As can be seen above, obtaining 13% from an 8% strategy is possible. As long as the interest is less than your RNOA, you experience a positive spread and a return boost. If the interest on the borrowed funds was 2%, or 5%, that net return would vary accordingly. It is important to combine both financial returns and operating returns to understand the total returns of a company. Two similar companies in the same industry may have the same returns, however, which would you rather own:

  • Company A: Total Return of 20% with RNOA of 5% and 4x Leverage
  • Company B: Total Return of 20% with RNOA of 13.3% and 1.5x Leverage

Digging deeper the other way is just as important. Breaking down returns into sources of return can give insight into what is generating profitability. This is hard to do with operational and financial returns mixed. However, once separated, you can see from RNOA which returns are from asset turnover and which are from margins. This gives you further insight into levers to pull for increased growth, and opportunities where you are below market when looking at benchmarked companies and industry numbers.

Much of the above goes much deeper into financial analysis and is beyond the scope of this letter. Here I simply wanted to show

  • What RNOA is
  • Why I love it
  • How it is the entrance into really understanding your business.


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