Posted on

How to Calculate Operating Return on Assets

3 min read

How to Calculate Operating Return on AssetsDuring Q3 of 2023, businesses in the United States made approximately $3.3 trillion, according to Statista. This is right behind the third quarter of 2022, when corporations in America made even more money. These figures are the net income of the respective periods, according to the National Income and Product Accounts (NIPA).

With profits reaching all-time highs since Q3 of 2012, understanding how businesses can analyze their profitability ratios through the Operating Return on Assets (OROA) ratio is another helpful tool for number crunchers.

Defining OROA

This calculation helps business owners and analysts determine how well a business is run. It shows the percentage, per dollar, that a business makes in operating income relative to assets involved in day-to-day operations. Unlike the regular return-on-assets (ROA) calculation, the Operating Return on Assets ratio takes a more selective consideration of assets. The primary consideration for the assets in OROA’s calculation is to only consider assets employed in a business’ traditional operations.

The calculation is as follows: 

OROA = Earnings Before Interest and Taxes (EBIT) / Average Total Assets

Another way to look at EBIT for the calculation is to look at the Income Statement’s Operating Income. For the average total assets, it’s taking a look at the business’ Balance Sheet and determining the two most recent yearly Total Assets for the company, that are used in its normal business activities.

Putting the OROA into practice, it’s calculated as follows:

OROA = $85,000 (Operating Income) / ($425,000 + $450,000) (Total Assets) / 2 =

  = $85,000 / 437,500

   = 0.1942 or 19.42 percent

This means that for every dollar of operating assets, the company has produced $0.1942 in operating income.

There are two important distinctions between OROA and the traditional ROA assets calculation. When it comes to income, OROA uses EBIT or Operating Income, but ROA uses net income as the numerator. With assets considered, OROA uses assets used for regular business operations, while ROA accounts for total assets in the calculation.

Interpreting Operating Return on Assets

One important way to use the result includes looking at a company’s OROA on a trended basis to determine if a business is declining, stagnating, or increasing its profitability.

Especially for investors, it’s important to contrast the OROA of the company at hand against rival businesses within the company’s same industry. When it comes to comparisons, the higher the OROA is, the better the result.

Another important consideration for investors is that OROA provides an accurate assessment of a business’ core operations. Since assets analyzed are for a business’ core profits or services, if a business reports profits from selling a division or it reports a one-time profit surge from investments, its core profitability is less likely to be skewed during investment analysis.

When used in conjunction with other accounting and financial metrics, businesses can continually measure and adjust their operations to increase efficiencies to increase their return on operating assets.

Posted on

6 Ways to Use Your Tax Refund

4 min read

6 Ways to Use Your Tax RefundGosh, it feels great to get that tax refund. Dreams of a much-needed vacation or a splurge on something you’ve been craving might be running through your mind. However, as unexciting as this sounds, you might want to spend this chunk of change on things that really matter. Here’s a list of smart uses for your tax refund that you’ll be glad you acted upon.

Build an Emergency Fund

Let’s face it. We depend on our machines to make life easier. However, these metal contraptions can (and will) break down. When this happens and you have money socked away, you won’t have to shell out a big part of your household budget to get them fixed or replaced. You’ll be prepared. Plus, saving money for something like this could also be a way to avoid stress. According to the American Psychological Association, 77 percent of Americans aged 35-44 say that money (or the lack of) is their main source of stress. The best way to save for the unexpected is to have a part of every paycheck auto drafted into a savings account – tuck those dollars away while you relax.

Pay Off Debt

Yes, at first blush, this doesn’t seem like a lot of fun. That said, carrying around debt and paying high interest rates can be a heavy burden to bear. Imagine how relieved you’ll be when you either pay off all your debt or a good portion of it. No longer will you be a slave to those monthly payments. And here’s a plus: Paying off your debt will improve your credit score. You ready?

Make a Down Payment on a New Car

Or, if you want to buy a good used one, buy it! But back to the new vehicles. When you get a new car, you not only get a new warranty and reliability, but also new technology and safety features. And word on the street is it that dealerships are starting to offer lower interest rates and great pricing incentives. Put your pedal to the metal on this one.

Pay Down Student Loans

Whether you’re a parent or child, this is a great use for a tax refund. Alleviating debt, no matter the source, is always a good thing. Now, you might hesitate given that President Biden recently canceled debt for a lot of students. However, this doesn’t apply to everyone, as some students have private loans and others don’t qualify. Another part of the upside of whittling away student debt is that there’s no penalty for paying more often and/or making extra payments. The sooner you get rid of this obligation, the more freedom you’ll experience.

Make Home Repairs

If you’ve been putting off getting a new water heater or replacing doors, now’s the time. Why? You may be eligible for tax credits for upgrading your home with “green” improvements. While not all renovations qualify, the ones that do include energy-efficient HVAC systems, windows, additional insulation, and modifying doorways for wheelchairs and walkers. That’s planning ahead!

Invest Your Money

If you’re not risk averse, the stock market is a good short-term option. However, if you’re more conservative, IRAs, CDs, and Treasury Bills are your best bet. The yield on the two aforementioned, T-bills and CDs, are higher than they’ve been in years, with many at 5 percent. Making money on your money is always a good idea.

What you decide to do with your tax refund is personal, depending on where you are in your life. There’s nothing wrong with splurging. However, in these uncertain times, putting it to good use could come in handy in the long run.

Sources

https://www.kiplinger.com/taxes/taxes/ways-to-spend-your-tax-refund

 

Posted on

Reduce Your Taxes by Putting the Right Assets in Your IRA

5 min read

Reduce Your Taxes by Putting the Right Assets in Your IRAMost people know the basic concept that certain types of investment accounts are tax sheltered while others are not. Think 401(k), 403(b), IRA and Roth IRA accounts, for example. What most people are not aware of is how you split your investment positions between your taxable and non-taxable accounts can result in major tax savings.

Asset Allocation and Location

One of the core principles of investing is to have an appropriate asset allocation that aligns with your risk tolerance and goals. In other words, how much of your investable net worth is in cash, stocks, bonds, precious metals, real estate, alternative assets, private investments, etc? Once you have this determined, the next consideration should be the location of these assets, primarily meaning whether you hold them in a taxable or tax-sheltered account.

The first, core principle behind asset location positioning is that bonds and other fixed income investments get the highest priority within tax sheltered accounts because they pay high-taxed ordinary income. Stocks that pay qualified dividends may be taxed at the more advantageous long-term capital gains rate, so they are typically better in taxable accounts.

What Are the Stakes?

To put it simply, big money. Take the example of a hypothetical $2 million portfolio evenly split between stocks and bonds. In the case where an investor has $1 million each in a taxable account (50/50 stock and bonds) and another $1 million in a tax-sheltered account (again 50/50 stock and bonds); this would cost about $148,000 over 30 years versus placing all the stock in a taxable account and all the bonds in a tax-sheltered account.

Asset Class Location Ranking

Of course, there are many more nuances and types of investments. Below we review 10 different types of assets, ranking them in order of those that get the most benefit from being in a tax-sheltered account with an explanation of why.

  1. K-1-Free Commodity Funds
    Popular for investing in futures, these are typically structured as Cayman Islands holding companies. As a result, they often kick-off highly taxed ordinary income even when the fund is losing money. Keep these in a tax-sheltered account at all costs.
  2. Junk Bonds
    High-yield corporate bonds typically come with large coupons (often 7 percent to 9 percent) and a small capital loss in the 1 percent to 2 percent range. Since the large coupon payment is taxed as ordinary income, while capital losses are worth less from a tax perspective, junk bonds are a prime candidate to go into a tax-sheltered account.
  3. Income Stocks
    Preferred shares and real estate investment trusts are characterized by their high unqualified dividends, so they are not eligible for preferential capital gains tax rates. This makes them best suited for a tax-sheltered account.
  4. High-Grade Bonds
    Similar to junk bonds, but with lower coupons and smaller capital losses, the benefits of holding these in a tax-sheltered account is less than the items above, but it is still preferable to place them in a tax-sheltered account.
  5. U.S. Treasuries
    The interest on U.S. Treasuries is taxed as ordinary income; however, it is exempt from state income tax. Depending on the state in which you are subject to taxes, these fall in the middle ground and could be held in either a taxable or tax-sheltered account.
  6. Actively Managed Mutual Funds
    The frequent churn of the holdings in actively managed funds typically creates more short-term capital gains versus long-term. Again, depending on total returns and how active the fund manager is, these could be held in either a taxable or tax-sheltered account.
  7. K-1 Commodity Funds
    Usually taxed as partnerships, profits typically get a 60/40 treatment, with 60 percent of gains classified as long-term and qualifying for favorable rates, putting them in the middle ground as well.
  8. High-Dividend Stocks
    For some investors, dividends are king. Think utility stocks and big-name blue chips with a steady track record of paying consistent dividends, like Altria. Since most, if not all, the dividend income is usually in the form of qualified dividends, holding these in a taxable account is much less painful.
  9. Stock Index Funds and Low Dividend Stocks
    Broader market mutual funds and ETFs have lower dividends. For example, on average, a total U.S. market ETF yields approximately 0.3 percent. Given this and their low churn, these funds are prime to be held in a taxable account, especially if the intended holding period is more than a year and will qualify you for long-term capital gains treatment and defer any taxable event until sale.
  10. Master Limited Partnerships (MLPs) and Private Real Estate Funds
    Typical of oil and natural gas pipeline investments, MLPs pay big dividends early on and they usually are not taxed in early years. Similarly, private placement real estate fund investments are shielded from the income they produce due to the upfront benefits of depreciation. Given their structure and the fact that they hold debt attributable to the owner, however, makes them a no-go for a tax-sheltered account since they create what is considered “unrelated business taxable income.” This makes these investments only suitable for a regular taxable account.

Conclusion

The decision of which types of investments you keep in either taxable or tax-sheltered accounts can make a big difference in how your investments grow and how much you keep. Consider evaluating not only your asset allocation but also your asset location to optimize for taxes.