Non-Operating Assets

What are Non-Operating Assets?

Non-operating or redundant, are assets that are owned by a company and are recorded on its balance sheets but do not support its core operations or business. The nature of non-operating assets has implications relating to company analysis and valuation.

It is crucial for any financial analyst to understand what non-operating assets are, why companies hold them, and how to identify and account for them in valuation models. Thus, we will cover each of these points in detail in this article.

In contrast to operating assets, non-operating assets do not contribute toward the generation of operating income. As a result, they are excluded from assets when calculating operating profitability ratios with assets as the denominator.

Companies hold these assets for a variety of reasons. For example, a company may hold excess cash in order to finance a growth opportunity without taking on external financing. It may invest in other companies for strategic reasons, such as growth or access to raw materials.

A company may also diversify risk by holding securities of companies in different markets and industries. It may also make use of derivative financial instruments to hedge its exposure to currency, interest rate, or commodity risk, among others.

Examples of Non-Operating Assets

In this section, we will discuss the most common examples of non-operating assets. It is worth noting that this is not an exhaustive list and that non-operating assets differ from one industry to another. Thus, their identification requires prudent judgment.

1. Cash and Cash Equivalents

The most common example is cash and cash equivalents or, more accurately, excess cash and cash equivalents. Cash is self-explanatory, and cash equivalents are short-term, highly liquid instruments such as treasury bills and commercial paper.

Only excess cash and cash equivalents are considered non-operating. Companies need cash to finance their daily operations, such as paying suppliers and employees. This portion of cash and cash equivalents is called operating or required cash.

However, in practice, it is difficult to identify the amount corresponding to operating cash and cash equivalents. Some advocate for 2% of sales as a general guideline, others use industry averages, and others consider the whole amount non-operating.

2. Marketable Securities

Another closely related example is marketable securities. These securities are also easy to liquidate, although not as easy as cash equivalents. Since they are not used in the business's daily operations, they are considered non-operating.

3. Equity Investments

Equity investments, or unconsolidated subsidiaries, are another example. They are companies in which the company has invested but holds less than 50% of equity. On the balance sheet, they are accounted for under the cost or equity methods.

4. Assets Held For Sale

Companies frequently also have assets held for sale on their balance sheets. These assets may be fixed assets that were once operational but the company intends to sell for some reason or long-term financial assets that the company will not hold till maturity.

Although the former contribute, or contributed, to the main operations of the company, they are classified as non-operating since they will not be a part of the company going forward. Thus, they are not a part of the company’s recurring business.

5. Unused Assets

A company may have an asset that is not currently operational but that may be at some time in the future. For example, it may have some vacant land that is unused at the moment. Such an asset is also considered non-operating.

Non-Operating Assets and Non-Operating Income

Non-operating income or loss is the income or loss generated by activities other than the company's core business activities. The concept is related to non-operating assets, as the former is generally generated by the latter, although this is not necessarily the case.

As with non-operating assets, what constitutes non-operating income differs from one company to another and across industries.

For example, interest income is considered non-operating when analyzing a manufacturing company and is generated by its non-operating excess cash and marketable securities.

On the other hand, the same income is considered operating when analyzing a bank and is generated by its operating loan portfolio assets. Interest income is the main operating income generated by banks.

Examples of the most common non-operating income and loss items include:

• Dividend income
• Gains and losses on the sale of assets
• Gains and losses on foreign currency exchange transactions
• Asset impairment charges

Real-World Examples of Non-Operating Assets

In this section, we take the balance sheets of two real-world companies to illustrate the process of identifying non-operating assets. First, we analyze the asset side of Apple’s balance sheet, as sourced from its 10-K, to give a simple example. 

Apple Inc. (AAPL)’s consolidated balance sheet on September 24, 2022 (in millions)

Apple’s balance sheet is relatively simple, and identifying the non-operating assets on it is a straightforward process. At first glance, we can identify cash and cash equivalents and marketable securities, current and non-current, as non-operating assets.

Since the notes to the financial statements do not give further information on the composition of other current and non-current assets, we can either treat the whole amount as operating assets or perform an industry analysis to estimate how much of it is related to operating assets.

Moving on, we analyze the asset side of DuPont’s balance sheet, also sourced from its 10-K, to give a more detailed example of how to identify non-operating assets. Analysts are more likely to encounter balance sheets with nuances like DuPont’s than Apple’s simple balance sheet.

DuPont de Nemours, Inc (DD) consolidated its balance sheet on December 31, 2022 (in millions)

While DuPont’s balance sheet is more complicated than Apple’s, it is also easy to identify some non-operating assets at first glance. These assets are cash and cash equivalents and marketable securities. The other items, however, require further investigation of the notes.

DuPont has engaged in heavy M&A activity in recent years. Certain amounts recorded are related to its acquisitions and divestitures, and since they are not related to the company’s core business of producing chemicals, they should be treated as non-operating assets.

For example, the company recorded indemnification assets relating to divestitures in accounts and notes receivable and deferred charges and other assets. It also recorded its unconsolidated subsidiaries in investments and non-current receivables.

Furthermore, the company classified the assets of a segment it intended to divest as assets of discontinued operations. Since these assets are not a part of the company’s operations going forward, they are considered non-operating assets.

This discussion is not intended to identify all of DuPont’s non-operating assets. Rather, it is a demonstration of how a careful evaluation of the notes to the financial statements allows one to dig deeper beyond the line items and identify hidden non-operating assets.

Treatment of Non-Operating Assets in Business Valuations

As we said in the introduction to this article, due to their nature, non-operating assets require special treatment when performing company analysis and valuation. Sometimes, they represent a significant portion of a company’s assets and, therefore, must be accounted for correctly.

Below, we discuss the treatment of non-operating assets in business valuations when using different valuation methodologies and how to value the assets themselves.

Valuation Techniques That Arrive At The Value Of Equity Directly

These techniques can yield either absolute valuations, such as discounted cash flow (DCF) based on free cash flow to equity (FCFE), or relative ones using a multiple with equity as the numerator, such as the price-to-earnings ratio (P/E).

The adjustment for these techniques is a bit tricky. It requires careful examination of the metric used and what it includes. For example, cash and cash equivalents generate interest income which is included in FCFE and earnings per share (EPS).

Valuation Techniques That Arrive At The Value Of The Whole Firm

These techniques can also be absolute or relative, such as DCF-based on free cash flow to the firm (FCFF) and multiples valuation using a multiple with enterprise value as the numerator, such as the enterprise value-to-EBITDA ratio (EV/EBITDA).

Since these techniques arrive at the value of the whole firm and do not consider any non-operating income, such as interest income, they require adjustments to derive equity value. These adjustments include adding non-operating assets and subtracting debt obligations.

Other Considerations

Note that non-operating assets should not be valued at their balances on the balance sheet, usually reflecting historical costs. Rather, they should be valued at net realizable value (NRV), which is the amount for which they can be sold minus any expenses related to their sale.

Failing to value these assets correctly and incorporate them in the model may lead to a widely inaccurate estimate of the company’s value. Thus, in the next section, we illustrate the general framework of this process.

Examples of Valuation of Non-Operating Assets

In this section of the article, we calculate the equity values of manufacturing company X, correctly accounting for non-operating assets. For the sake of simplicity, we value X first using DCF with FCFF as the cash flow and then using an EV/EBITDA multiple.

Company X’s consolidated balance sheet on December 31, 2022 (in millions)

Assume that all cash and cash equivalents are in excess and that there are no non-operating assets included in other current assets or other assets. Assume also that the amounts recorded on the balance sheet reflect the net realizable values of the assets.

We can identify the non-operating assets as consisting of cash and cash equivalents, marketable securities, assets held for sale, and equity investments. Now, we value the company using the information below:

First, we take the DCF approach. We value company X using a perpetuity growth model at a constant growth rate of 2%. The formula for the perpetuity growth model is

Enterprise value = FCFF₁ / (WACC - g)

By plugging in the numbers, we arrive at an enterprise value of $13 billion. Next, we add the value of non-operating assets and subtract debt, leaving us with an equity value of $10,185 million. Dividing that amount by the number of shares, we can value the company at $20.37 per share.

The last thing we are going to do is a multiples valuation. By applying an EV/EBITDA multiple of 16x, we get an enterprise value of $13 billion, the same value as the DCF approach yielded. We can then make the necessary adjustments and arrive at the same equity value per share.

If you would like to learn more about DCF modeling, be sure to check out our course on the topic!

Researched & Authored by Adham Touny | LinkedIn

Reviewed and edited by Alexander Bellucci | LinkedIn

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