When calculating the value of a business, it’s easy to focus on the tangible and operational aspects—the equipment, the inventory, and the day-to-day cash flow that keep things moving. But there’s another important factor that can significantly impact valuation: non-operating assets. These are items that exist on the Balance Sheet but aren’t directly tied to running or sustaining the business. Let’s dive into what they are, why they matter, and how to calculate them.
What Are Non-Operating Assets?
Non-operating assets include any assets or liabilities on the Balance Sheet that are not essential to the daily operations of the business. In simpler terms, these are items that the business owns (or owes) but doesn’t rely on to generate revenue or sustain its core operations. Identifying these items is critical because they represent additional value (or obligations) outside of what is needed to run the business.
Some common categories of non-operating assets include:
- Excess Working Capital: Often the most significant non-operating asset, this includes excess cash or liquid assets beyond what the business needs to meet its day-to-day obligations. We determine this by analyzing the business’s net working capital (current assets minus current liabilities) and comparing it to industry benchmarks and historical working capital requirements.
- Shareholder and Related Party Items: These are amounts the business owes to or is owed by shareholders and/or related parties. They often appear on the Balance Sheet as “Due to Shareholder” or “Due from Shareholder.”
- Non-Operational Assets: This includes assets owned by the business but not primarily used for business purposes, such as personal-use vehicles, vacation properties, or other non-essential items.
- Marketable Securities: Investments in stocks, bonds, or other securities that the business holds but doesn’t rely on for operational needs.
- Cash Surrender Value of Insurance Policies: The cash value of life insurance policies owned by the business that aren’t tied to its operations.
Why Are Non-Operating Assets Important?
Non-operating assets are significant because they contribute to the overall value of the business but aren’t factored into its operational performance. Ignoring these items can lead to an incomplete or inaccurate valuation. For example, if a business has a large amount of excess cash or a personal-use vehicle included on the Balance Sheet, these items inflate the business’s apparent value unless accounted for separately.
By isolating non-operating assets, we can:
- Provide a clearer picture of the business’s operational value.
- Ensure that excess value—or liabilities—is appropriately accounted for.
- Help business owners and advisors make better decisions about how to manage, allocate and/or extract these resources.
Calculating Non-Operating Assets
Identifying and calculating non-operating assets involves a detailed review of the Balance Sheet. Let’s walk through an example:
Example Business: ABC Manufacturing Ltd.
Balance Sheet Highlights:
- Cash: $100,000
- Accounts Receivable: $5,000
- Inventory: $25,000
- Accounts Payable: $40,000
- Due to Shareholder: $50,000
- Personal-Use Vehicle (FMV): $30,000
Step 1: Determine Excess Working Capital To calculate excess cash, we first assess the business’s working capital needs. Let’s assume:
- Industry Current Ratio Benchmark: 1.8
- Historical Working Capital Requirement: $60,000
Current Ratio: (Cash + Accounts Receivable + Inventory) / Accounts Payable = ($100,000 + $5,000 + $25,000) / $40,000 = 3.25
This is significantly higher than the industry benchmark, indicating potential excess working capital. Based on historical requirements, we determine the business needs $60,000 in working capital. Since current net working capital (cash, receivables, and inventory minus accounts payable) totals $90,000 , excess working capital is:
$90,000 - $60,000 = $30,000
Since the current Cash balance ($100,000) exceeds this amount, we can determine that in this instance, the amount of Excess Cash on the Balance Sheet is $30,000.
Step 2: Identify Other Non-Operating Assets and Liabilities Next, we identify other items:
- Personal-Use Vehicle: The FMV of $30,000 is included as a non-operating asset because it’s not required for the business.
- Due to Shareholder: This $50,000 liability is a non-operating liability because it’s a personal obligation owed to the shareholder.
Step 3: Calculate Net Non-Operating Assets Now, we total up the non-operating items:
- Non-Operating Assets: Excess Cash ($30,000) + Personal-Use Vehicle ($30,000) = $60,000
- Non-Operating Liabilities: Due to Shareholder ($50,000)
Net Non-Operating Assets: $60,000 - $50,000 = $10,000
Putting It All Together
In this example, ABC Manufacturing Ltd. has $10,000 in net non-operating assets. This value will be added to the operational valuation of the business to arrive at the total overall value.
Final Thoughts
Understanding and calculating non-operating assets is a crucial part of business valuation. These items can significantly impact the overall value of a business, and identifying them ensures that the valuation reflects reality. By isolating non-operating assets and liabilities, advisors and business owners can make better decisions about how to manage these resources—whether that means reinvesting excess cash into the business, addressing shareholder obligations, or simply getting a clearer picture of what’s driving (or limiting) value.
In the next post, we’ll explore the role of cash flow in business valuation—how it’s calculated, why it’s a cornerstone of valuation, and how you can improve it to drive sustainable growth. Stay tuned!
Authors: Colin Szemenyei and Gary Sanghera, CPA, CMA, CBV
