Non-Current Assets
These are long-term assets, are part of total assets, and are reported on the balance sheet under the noncurrent assets/assets section.
What are Non-Current Assets?
Non-current assets are also called long-term assets. Non-current assets are part of total assets. Non-current assets are mentioned on the balance sheet under the asset section after current assets.
Non-current assets are illiquid; such assets can not be sold/bought easily at a reasonable price. Illiquid assets increase the risk of the company to meet its short-term obligations.
Non-current assets are composed of the following:
- Long-term investments
- Tangible fixed assets
- Intangible assets
Non-current assets can further be sub-categorized as follows:
- Long-term investments will include financial assets
- Tangible fixed assets will include fixed and immovable assets
- Intangible assets will include assets that lack existence
Long-term investments include financial assets such as investments in long-term bonds and investments in stock.
Tangible fixed assets are fixed and immovable and have a physical value. The company uses tangible fixed assets to produce its products. Such assets are a larger percentage of total assets. Examples are property, plant, and equipment, which include Machinery, Factories, etc.
Intangible assets have no physical appearance/existence. An example of an intangible asset would include goodwill. Goodwill is an intangible asset that is recognized in a business combination like merger and acquisition.
Key Takeaways
- Noncurrent assets are long-term assets, are part of total assets, and are reported on the balance sheet under the noncurrent assets/assets section.
- Noncurrent assets are illiquid and can’t be transacted easily.
- Examples of noncurrent assets include Long-term investments, Tangible fixed assets, and Intangible assets.
- Tangible fixed assets have a physical value. Machinery, Factories, and PPE are considered tangible fixed assets
- Intangible assets have no physical existence. Goodwill is considered an example of an intangible asset.
Understanding Non-Current Assets
Let's go through non-current assets, such as long-term investments, tangible fixed and intangible assets, in detail.
1. Long-term investments
Financial assets included in long-term investments are long-term bonds, stocks, and real estate.
A. Investment in Long-term Bonds
The issuer issues long-term bonds to raise capital, which is a liability of the issuer. The holder of a bond is called a bondholder.
In this case, the company is a bondholder as it is going to invest in long-term bonds(non-current assets). The bond issuer is required to make coupon payments to the bondholder.
The coupon payment is based on the bond's coupon rate and face value. The company is also required to repay the principal at the bond's maturity.
Bonds are issued at a discount, premium, or par.
- Bonds that are issued at par trade at a price equal to the face value of the bond.
- Bonds that are issued at a discount work at a price less than the bond’s face value.
- Bonds that are issued at a premium work at a price greater than the bond’s face value.
Bonds trade at a discount when the bond's yield to maturity is higher than the bond's coupon rate.
Bonds trade at a premium when the bond's yield to maturity is less than the bond's coupon rate. Bonds trade at par when the bond's yield to maturity is equal to its coupon rate offered.
B. Investment in Stocks
Stocks provide stockholders with a share of ownership in a company. Stocks can be classified based on the size of large, small, and mid-cap stocks.
Stocks can also be classified based on style as value stocks or growth stocks. Stock can be preferred stock or common stock.
- Large companies issue large-cap stocks with a high market capitalization in the approximate range of $2.943 trillion and $77.51 billion.
- Small companies issue small-cap stocks with a low market capitalization in the approximate range of $300 million and $2 billion.
- Mid or medium-sized companies issue mid-cap stocks with neither too high nor too low market capitalization.
Value Stocks trade at a lower price and have a high book value to market value ratio. Also, the dividend yield provided by value stocks is high.
Note
Growth stocks have higher market value, low book value to market value ratio, low dividend yield, and higher prices.
Preferred stockholders enjoy preference in terms of dividend payments. Common shareholders bear the highest risk and have residual claims after all obligations are met.
2. Tangible fixed assets
Property, plant, and equipment are the main subset of tangible fixed assets. Property, plant, and equipment include land, buildings, factories, warehouses, machinery, etc.
Note
These assets are required in companies’ manufacturing and production processes.
Property, plant, and equipment purchase costs are high, and also there are associated costs such as installation charges, the cost of training employees on how to use the assets, etc.; therefore, the initial investment in this asset is larger and represents a larger percentage of total assets.
Such assets are depreciated every year. Their value decreases with more users, and repair and maintenance costs will increase over time.
3. Intangible assets
Goodwill is an intangible that has no physical existence. Goodwill is created in a business combination.
Types of business combinations, also called mergers, are horizontal mergers, vertical mergers, conglomerate mergers, or acquisitions. In a merger, the acquirer acquires all the target company's assets. In acquisition, only a few segments/assets are bought by the acquirer.
Goodwill is recorded in the acquirer's balance sheet when an acquirer acquires a target and pays a sum of money above the net value of the target’s identifiable assets.
Goodwill calculation is based on the purchase price paid and the difference between the fair market value of the assets and liabilities.
Non-Current Assets Valuation
Long-term investments valuation. The valuation model being used is the discounted cash flow model, also known as the DCF model.
Long-term investments can be valued using discounted cash flow models. The DCF model states that the value of any investment presently is the summation of the present value of future cash flows discounted using a relevant discount rate.
Cash flow for bonds is coupons, and cash flow in the final year also includes principal. Cash flows for stocks are dividends, and cash flow in the final year also includes the selling price for the stock.
Value of asset today = CF year 1/(1 + DR)1 + CF year 2/(1 + DR)2 +...+ CF year N/(1 + DR)N
Where,
- CF= Cash flow
- DR= Discount rate
- N= Number of years
Let’s take an example.
The stock dividends are mentioned below:
- A dividend of $1 is paid in year 1
- A dividend of $1.2 is paid in year 2
- A dividend of $1.5 is paid in year 3
The selling price in the final year is $60. The discount rate is 5%.
Calculating the value:
stock value = ($1/ (1 + 0.05)1) + ($1.2/ (1 + 0.05)2) + ($1.5 + $60/ (1 + 0.05)3)
= $0.95 + $1.09 + $53.13 = $55.17
An important principle of investing in the stock market is that overvalued stocks should be sold/not bought, and underpriced stocks should be bought/not sold. Fairly valued stocks should be held.
Let’s see how we calculate Property, Plant, and Equipment Valuation (PPE).
To calculate PPE, add gross PPE to capital expenditures and subtract accumulated depreciation.
Note
Gross PPE is the total cost paid for all assets at the beginning of the year.
Property, plant, and equipment value = Gross PPE + Capital expenditure - Accumulated depreciation
For example:
- Gross PPE = $860,000
- Capital expenditure = $50,000
- Accumulated depreciation = $2,000
Calculating the value:
PPE value = $860,000 + $50,000 - $2,000 = $908,000
Now, let’s calculate Goodwill: We can base goodwill value on the purchase price that is agreed upon by the acquiring firm to pay to the target, the fair market value of the assets of the target, and the fair market value of the liabilities of the target.
Goodwill = Purchase price - (Fair market value of assets - Fair market value of liabilities)
For example:
- The fair market value of assets = $900,000
- The fair market value of liabilities = $670,000
- Purchase price = $7,000,000
Calculating Goodwill
= $7,000,000 - ($900,000 - $670,000) = $6,770,000
Impact of Increase/Decrease in Non-Current Assets on Financial Variables
An increase in non-current assets is directly correlated to having more long-term assets. The uses of having more long-term assets examples are:
Let us take a few examples. A capital gain, also called the price appreciation return on a stock can be used to achieve/meet any long-term obligation.
Coupon payments on the long-term bond could be used to fund long-term liabilities that require periodic payments.
Part of PPE could be sold to generate cash to pay some of the long-term liabilities.
A decrease in liabilities will enhance the company's risk status, and such a company would likely be regarded as less risky by the investors.
This leads to a reduction in the cost of financing and increases the company's value.
A decrease in non-current assets is equivalent to having fewer long-term assets, which would negatively impact the company.
Not being able to meet long-term liabilities increases risk, increases the cost of capital, and will decrease the value/worth of the company in the minds of all investors.
Calculations Related to Non-Current Assets
Non-current assets are part of total assets.
Noncurrent assets can be estimated using the below-mentioned formula:
Noncurrent assets = Total assets - Current assets
Consider the following:
- Total assets = $40,000,000
- Current assets = $500,000.
We can solve for noncurrent assets as follows:
=$40,000,000 - $500,000
= $39,500,000
Noncurrent assets can be estimated in percentage terms using the below-mentioned formula,
The formula for Noncurrent assets expressed as a percentage of total assets
Noncurrent assets = 100% - Current assets as a percentage of total assets
For example: If current assets are 40% of total assets, then noncurrent assets as % of total assets will be 100% - 40% = 60%
Suppose,
Total assets =$40,000,000
Solving for noncurrent assets =60% of $40,000,000 =$24,000,000.
Note
Fixed assets such as PPE are a component of non-current assets.
Let’s go through the fixed asset turnover ratio.
Fixed asset turnover = Net sales/Average fixed assets
Average fixed assets = (Beginning year fixed assets + Ending year fixed assets)/2
For example:
- Net sales = $40,000
- Beginning year fixed assets = $79,000
- Ending year fixed assets = $80,000
- Average fixed assets = ($79,000 + $80,000)/ 2 = $79,500
Fixed asset turnover = $40,000/ $79,500 = 0.50 times
Stocks are components of long-term investments, which are non-current assets. Let’s find stock returns.
Note
Stock total return includes dividends and capital gain/capital loss (also called price appreciation).
Dividends are cash flows, and price appreciation can be calculated based on the ending and beginning stock prices.
A capital gain is summarized as a positive value added/earned from the ending value of the stock being greater than the initial stock value.
Stock total return = (Ending stock price - Beginning stock price + Dividends)/ Beginning stock price
For example:
- Beginning stock price = $40,000
- Ending stock price =$50,000
- Dividends = $5,000
Stock total return = ($50,000 - $40,000 + $5,000)/ $40,000 = 0.375, which is 37.50%
Non-Current Assets FAQs
Current assets can be easily converted into cash and are short-term in nature, whereas noncurrent assets have liquidity risk and hence cannot be converted into cash easily. They are held for a longer duration.
Long-term investments, PPE, and Goodwill are a few examples of noncurrent assets.
Yes, machinery is a noncurrent asset and helps in the production of goods.
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