What are Redundant Assets?
Redundant assets are assets that generate income for the business but that are not essential to the normal operations of the business. In simple terms, they are assets that are owned by the company that 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 price that represents the true value of the business. The seller may choose to retain the redundant assets when selling the business. This is because the assets are not directly required for the provision of the company’s products or services. Although they are recognized as assets, they have no essential operating purpose for the enterprise. Hence, they are inconsequential to the buyer and only important to the seller.
Examples of Redundant Assets
Redundant assets are most prevalent in privately-owned businesses. This is because 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 as follows:
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. These assets may include boats, recreational vehicles, or an aircraft. They may be used by the company’s employees either during 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 income from doing so.
Real estate properties are redundant assets when the company does not engage in real estate as part of its core operations. When a business owns locations that are no longer operational, the buildings are recognized as non-operating assets. This is 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. In contrast, when a real estate company owns its 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 does not operate in the marketable securities industry. Therefore, a company that trades in securities outside of its core operations derives non-operating income from them.
These assets should be adjusted when calculating the fair market value of the company during a merger or acquisition transaction. Securities are only recognized as operating assets if the company undertakes trading activity as part of its core business.
Excess non-cash working capital
When a company records non-cash working capital in excess of what the company requires to maintain revenues, it is classified as a redundant asset. The company does not need the excess working capital, such as inventory, to conduct its core operations and generate revenue.
Sellers should be cautious when determining the amount of non-cash 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 proper amount without adversely 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 risk. During periods of financial distress when revenues are not sufficient to support the business, non-operating assets provide additional cash flows.
Revenues from non-operating assets can act as a financial backup. For example, a distribution company that owns multiple warehouses may lease out some of its warehouses to other companies. Thus, it earns non-operating income to supplement its core revenues.
Companies may also invest in redundant assets such as real estate and hotels as a way of earning income even after disposing of the business. For example, where the seller owns various commercial buildings that are not part of the company’s operations, the seller may 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.
Acquiring non-operational assets may also provide a means of reducing operating costs. For example, a company that does landscaping may acquire a nursery as a way of reducing supply costs.
Valuation of redundant assets
When evaluating a company, non-operating assets are treated differently from operating assets, but may still be important in calculating the overall worth of the company. Typically, such assets are 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 usually remove the redundant assets from the company’s valuation. If the buyers are interested in them, then the seller must be adequately compensated for both operating and non-operating assets.
Non-operating income, also known as incidental income, is 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.
Thank you for reading CFI’s explanation of Redundant Assets. 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: