By Amber Hoover, CPA/ABV
Senior Analyst, Valuation and Litigation Services
What are non-operating assets? In the context of a business valuation, the Statement on Standards for Valuation Services (SSVS) defines a non-operating asset as one not necessary to ongoing operations of the business. Thus the business entity could continue to operate without the non-operating asset (or liability).
Non-operating assets and liabilities can be especially prevalent in privately held businesses. Some examples of non-operating assets would be items owned by a business with little business purpose; for example, a condo in Florida, a boat, a recreational vehicle, etc.
These assets, while potentially permissible as a business asset in many cases, serve no essential operating purpose for the business entity from the perspective of a potential buyer. Instead they are perks for the existing business owner.
Another form of non-operating assets (or liabilities) are shareholder receivables or loans. For many small businesses capital is difficult to come by. So the business owner often funds operations from their “take” of the businesses’ profits. Managing the flow of funds in and out of a company with the tax regulations that currently exist often result in shareholder receivables and loans.
While these items may be popular in small businesses, they are typically viewed as “equity” transactions from a valuation perspective and thus excluded from the operating value of a business.
A final form of non-operating asset is the existence of “Excess” assets. Excess assets can be identified as a result of comparisons of the subject company being valued to other companies in the same industry or line of business. In situations where there is a substantial upside difference in asset category between the subject and the subject’s peers, it is arguable that the business’s performance is superior and thus has accumulated an “excess” that other businesses have not.
The excess (i.e. cash, marketable securities, etc.) is thus treated as a non-operating item because the peer group operates effectively and efficiently without such excess, and so should the subject business. The excess may also represent an accumulation of working capital far beyond what is necessary for ordinary business operations.
The business valuation process necessitates identification of non-operating assets (and liabilities). Once identified, what do you do with these items? Because these non-operating items are “owned” by the business they should be included in the value of the overall business.
However, because these items are not essential to operations they need to be isolated and removed (and any income or expense associated with them removed) from the determination of the operational value of a business. Typically, non-operating assets are an add-back to the valuation methodologies after determining the operating value of the business.
For divorce purposes, non-operating assets and liabilities related to the business owner may also be a corresponding personal asset or liability on a marital balance sheet. In many cases, the value of a non-operating item, if personal to the business owner, has an offsetting impact to the business owner’s marital estate.
For example, a company that has a shareholder receivable (company’s non-operating asset) would have as part of its overall value this shareholder receivable. For this shareholder receivable to have value, there would be an expectation of repayment by the shareholder of this personal debt. Thus the shareholder has a personal liability for the same value as the shareholder receivable (or company’s non-operating asset).
Accordingly, the proper identification and classification of non-operating assets is a critical step in the analysis of the equity value of a business. As stated above, in the case of a marital divorce, non-operating assets may add to the complexity in properly determining the value of a marital estate.
If you have any questions about non-operating assets or liabilities, please contact Amber Hoover at (317) 613-7844 or [email protected].