Non operating asset
|Non operating asset|
Non operating assets are not directly recognized in the balance sheet. They comprise valuable corporate assets that do not participate in the process of generating operational cash flows and are its property at the time of valuation. To asses their value, companies use income methods of enterprise valuation.
Examples of non operating assets
Examples of non operating assets(A.A. Muaaz 2012 p.3):
- holdings which can include public and private companies
- low-risk investements popular for companies with big cash balances
- equity investements for strategic or investement reasons
Nature of non operating assets
These assets can have value for example as land or pension plan but they do not generate cash flows. Because of that it is very important for companies to value their value well. Very often the main reason of investing in non operating assets is strategy. Non operating assets do not bring benefits to current operations and they may also not benefit the company in the future but a lot of companies see opportunity of using these assets in the future as a weapon in worse times. One way to use non operating assets is to buy assets from company in bankruptcy at bargain prices (A.A. Muaaz 2012 p. 3-5).
Valuation of non operating assets
We distinguish two methods of valuating assets:
- DCF method
- FCF method
DCF method estimates cash flow that is, it focuses on the value of factors which have impact on cash flow. FCF method is closely linked to management decision. This method most accurately shows the scenario of the company future. Non operatimg assets should be valuated by this method just like other assets. They are equally important for the company's strategy as well as decisions made by managers (P. Mielcarz 2011 p.2-3). The second way to value non operatin assets is using fair value method or historical cost accounting. The first one is implemented when operational results are provided at a lower cost. Historical costs accounting requires periodic checking of assets impairment. If depreciated historical costs are higher than fair value then assets whose value is close to fair value are subject to valuation. Companies can choose between these two method freely because of rules in International Financial Reporting Standards (H.B Christensen 2013 p. 734-736, 771).
Advantages of Non operating asset
Non operating assets can provide many advantages to a company such as:
- Increased liquidity and flexibility in the company's operations and finances as non-operating assets can be sold off quickly and easily to raise short-term funds.
- Improved returns on investment as non-operating assets can be invested in higher-yielding investments than the company's primary business.
- Diversified portfolio which can reduce risk associated with the company's primary business.
- Higher valuation as non-operating assets can be used to demonstrate a company has a diverse range of assets and is less reliant on its primary business.
- Use of non-operating assets as collateral to secure loans, which can provide access to funds at lower costs.
Limitations of Non operating asset
Non operating assets have certain limitations that may affect their value and reliability as a financial tool. These include:
- Lack of liquidity: Non operating assets cannot be easily converted into cash, thus making them difficult for companies to use to generate capital.
- Lack of standardization: Non operating assets are not standardized across different companies, making it hard to compare and value them accurately.
- High costs of acquisition and maintenance: Non operating assets can be costly to acquire and maintain, which can be a financial burden for some companies.
- Difficulty in valuing: Non operating assets can be difficult to value, as their value can fluctuate and depend on various factors.
- Difficult to track: Non operating assets can be hard to track, as their ownership and location can change over time.
Non operating assets can be valued through a variety of different approaches, such as:
- Market value approach - This method uses the market value of comparable companies to value the non-operating asset. This approach is useful when a company is operating in an industry with a deep and liquid market.
- Cost approach - This approach uses the cost of acquiring the asset, plus the costs associated with maintaining it over time. This is useful for assets with a long lifespan, such as buildings and machinery.
- Income approach - This approach uses the expected future income generated by the asset to value it. This approach is useful for assets that generate revenue, such as real estate investments.
In summary, non operating assets can be valued through a variety of approaches, including the market value, cost, and income approaches. Each approach has its own advantages and disadvantages depending on the type of asset being valued.
- Beneda N.L. (2004) Valuing Operating Assets in Place and Computing Economic Value Added The CPA Journal, New York Volume 74, no/release 11, p.56-61.
- Christensen H.B., Nikolaev V.V. (2013) Does fair value accounting for non-financial assets pass the market test? Review of Accounting Studies, Volume 18, Issue 3 p.734-775.
- Damodaran A. (2005) Dealing with Cash, Cross Holdings and Other Non-Operating Assets: Approaches and Implications. Stern School of Business, p.1-55
- Mielcarz P., Wnuczak P. (2011) DCF Fair Value Valuation, Excessive Assetes and Hidden Inefficiencies. Kozminski University Poland Issue 4 p.44-57.
- Muaaz A.A. (2012) Idle Assets Utilization and firm value. Kuwait University - College of Business Administration, p.1-32.
Author: Angelika Orlof