What are Redundant Assets?
Redundant assets are assets that generate income for the business but are not essential to the normal operations of the business. In simple terms, they are assets that are owned by the company but do not contribute to the core operations and revenue-generating activities of the company. Redundant assets are also known as non-operating assets.
When a company is being evaluated, redundant assets are excluded from the valuation in order to arrive at a fair market value that represents the true value of the business. The seller may choose to retain the redundant assets when selling the business to a buyer because the assets are not directly required for the provision of products or services. Although they are recognized as business assets, redundant assets have no essential operating purpose for the enterprise from the buyer’s perspective and are only important to the seller.
Examples of redundant assets
Redundant assets are most prevalent in privately-owned businesses since the owners enjoy the freedom to purchase assets that are not necessarily required for the normal operations of the business. Examples of redundant assets are:
Tangible assets not used directly in the business operations
In the course of its operations, a business may acquire certain types of assets to facilitate the smooth operations of the company. The assets may include boats, recreational vehicles, or an aircraft. They may be used by the company’s employees either during their normal operations or for leisure activities. Removing the assets from the business will not affect the normal operations of the business. When not in use, the business may lease them out to other businesses and earn an income from it.
Real estate properties are recognized as redundant assets when the company does not engage in real estate activities as part of its core operations. Additionally, when the business owns other business locations that are no longer operational, buildings are recognized as non-operating assets because they are no longer essential to its normal operations.
The buildings can be rented out to other businesses to bring in non-operating income. However, when a real estate company owns it own residential and commercial buildings, these assets are recognized as operating assets since they are essential to the company’s operations.
Marketable securities are considered redundant assets when the company itself does not operate in the marketable securities and trading industry. Therefore, a company that trades in marketable securities outside of its core operations derives non-operating income that helps boost the company’s revenues.
The assets should be adjusted when calculating the fair market value of the company during a merger or acquisition transaction. The marketable securities are only recognized as operating assets if the company undertakes the activity as part of its core operating activities.
Excess non-cash working capital
When a company records non-cash working capital that is in excess of what the company requires to maintain the revenues, the additional non-cash working capital should be classified as a redundant asset. The company does not need the excess working capital such as inventory and receivables in order to conduct its core operations and generate revenues.
When sellers are planning to sell off their businesses, they should be cautious when determining the amount non-working capital that is considered redundant, since overstating or understating the figure may affect the actual valuation of the company. Sellers can work with experienced valuation specialists to determine the amount of redundant non-working capital without affecting the fair market value of the company.
How do companies use redundant assets?
The main reason why companies invest in non-operating assets is to diversify risks. During periods of financial distress when revenues are not sufficient to support the business, the non-operating assets provide additional cash flows to supplement revenues from its regular operations.
Also, when the business incurs losses in its core operating activities, revenues from the non-operating assets can act as a financial backup. For example, a distributorship company that owns multiple warehouses in different locations may lease out some of its warehouses to other companies and earn a non-operating income to support its core operations.
Companies may also invest in redundant assets like real estate and hotels as a way of earning income even after disposing of the business. For example, where seller owns various commercial buildings that are not part of the company’s operations, the seller will continue leasing them out even after the business has been sold. In some instances, the buyer will become the first tenant if they agree to continue operating the business at the seller’s premises. The same case applies to other non-operating assets such as hotels and recreational cars.
Valuation of redundant assets
When evaluating a company, non-operating assets are treated differently from operating assets, but the former counts when calculating the overall worth of the company. Typically, the assets are usually excluded when calculating the profitability and net income of the company.
Redundant assets should not be valued using the capitalization or discounting method. Instead, they should be valued at their net realizable value after deducting distribution and disposition costs. The value obtained is added to the operational value of the company to get the enterprise value.
When disposing of the business, the sellers remove the redundant assets from the company’s valuation, or if the buyers are interested in them, the sellers must be adequately compensated for both the operating and non-operating assets.
Non-operating income, also known as incidental income, is an income earned from non-core operations of a company. Some of the incomes are derived from non-operating assets while others are obtained from other sources. Examples of non-operating incomes derived from non-operating assets include rental incomes from real estate properties and incomes from discontinued assets of the business.
Other incomes categorized under non-operating incomes include foreign exchange income, gains on marketable securities, asset write-downs, and dividend income.
CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful: