Managerial accounting involves using a company’s financial and other data to help management monitor its performance and make decisions. Return on investment measures how much net operating income a business generates in a certain period as a percentage of its average operating assets. ROI tells you how well you are using the resources in your business to generate operating profit.
Determining Net Operating Income
Net operating income for a particular period equals sales revenue minus cost of goods sold, minus operating expenses, such as selling and administrative expenses. Do not subtract interest expense or income tax expense in your calculation. For example, if you had $100,000 in sales, $50,000 in cost of goods sold and $20,000 in selling and administrative expenses during the past year, calculate $100,000 minus $50,000 minus $20,000 to get $30,000 in net operating income.
Operating Assets Definition
Operating assets are the resources you use in your small business to generate operating income. Examples include cash, inventory, accounts receivable, buildings and equipment. When figuring the value of operating assets that are depreciated, such as property or equipment, you can use either the net book value -- which equals original cost minus accumulated depreciation -- or the original cost. Make sure you use one or the other consistently when calculating ROIs for different divisions of your business.
Figuring Average Operating Assets
The formula for average operating assets is beginning operating assets plus ending operating assets, with the result divided by 2. In the formula, beginning and ending operating assets represent the total value of your operating assets at the beginning and end of the period, respectively. For example, if you have $90,000 in operating assets at the beginning of the year and $110,000 in operating assets at the end of the year, calculate $110,000 plus $90,000 and divide it by 2, which equals $100,000 in average operating assets.
ROI equals net operating income divided by average operating assets times 100. For example, if your small business has $30,000 in net operating income and $100,000 in average operating assets, your ROI would be $30,000 divided by $100,000 times 100, which is 30 percent. This means your small business generated net operating income equal to 30 percent of your average operating assets.
Compare your ROI over different time periods and between divisions to monitor your efficiency. A higher ROI is better than a lower one. An acceptable ROI level varies based on various factors, such as a company’s cost of capital and risk level. In general, your ROI should be greater than the percentage annual cost you pay your creditors and investors to use their capital; otherwise you would pay more for your capital than you earn from investing it in your business.
- PrinciplesofAccounting.com: Chapter 17 -- Introduction to Managerial Accounting
- Accounting For Management: Return on Investment (ROI) Method for Measuring Managerial Performance
- Cornerstones of Managerial Accounting, Fourth Edition: Maryanne M. Mowen et al.
- The Essentials of Finance and Accounting for Nonfinancial Managers, Second Edition: Edward Fields
- John Foxx/Stockbyte/Getty Images