How Do Non-Operating Assets and Liabilities Affect Business Value?
When valuing a business, it’s important to identify nonoperating assets and liabilities. These nonessential items may have more or less risk than core business operations — and they may have a significant impact on value.
Operating vs. Non-Operating Assets
Non-Operating assets and liabilities aren’t necessary to ongoing business operations. Common examples include:
- Excess cash or working capital,
- Marketable securities,
- Real estate investments,
- Personal property, such as a collection of artwork or luxury vehicles,
- Companies that are unrelated to current business activities, and
- Real estate, equipment or other assets associated with discontinued operations.
Companies with nonoperating assets may incur liabilities associated with these assets. And some nonoperating items generate income or expenses that must be removed from the business’s income statement to value ongoing business operations.
Nonoperating items are typically valued separately and then added (or subtracted) to arrive at enterprise value. Valuation methods for nonoperating assets depend on the nature of the assets. For example, real estate would typically require an appraisal, while an investment in another company would likely require a separate business valuation.
Val, a business valuation expert, was hired to appraise ABC Manufacturing for M&A purposes. When reviewing the company’s balance sheet, Val discovered a nonoperating asset: a parcel of undeveloped land that was recently appraised at $1.5 million. The land generates no income, but it incurs property taxes, insurance, and other operating costs. The company also has a $350,000 loan on the property.
To value ABC’s manufacturing operations, Val excludes the expenses related to the vacant land from her discounted cash flow analysis. She determines that the value of ABC’s core operations is $3.35 million (excluding debt). Then she adds back the value of the land ($1.5 million) and subtracts the outstanding loan balance ($350,000). As a result, the value of the business’s equity, including nonoperating assets, is $4.5 million.
This approach provides a reliable picture of ABC’s value to a hypothetical buyer, who would have the ability to sell the real estate and eliminate the related expenses. Treatment of nonoperating assets and liabilities may depend in part on the purpose of the valuation, the standard of value (for example, fair market value vs. fair value) and the level of value (for example, controlling vs. minority interest).
In the hypothetical example, Val didn’t just accept the balance sheet at face value. Rather than assuming that all assets and liabilities are part of a business’s core operations, it’s important to investigate whether the subject company has nonoperating assets and liabilities that distort its potential earnings and value.