Understand the Concept of Operating Assets
What are Operating Assets?
Operating Assets are necessary to a company’s ongoing core operations and directly support the continued generation of revenue and profits. Table of Contents
- Operating Assets Definition
- Operating Assets Formula
- Operating vs Non-Operating Assets
- Valuation of Operating Assets
- Intrinsic Valuation (DCF)
- Relative Valuation
Operating Assets Definition
Operating assets have an integral role in the core business model of a company. If an asset is required for day-to-day operations to sustain itself, it is most likely an operating asset since its contribution is essential. Common examples of operating assets include the following:
- Property, Plant & Equipment (PP&E)
- Accounts Receivable (A/R)
- Recognized Intangible Assets (e.g. Patents, Intellectual Property)
Operating Assets Formula
The value of a company’s operating assets is equal to the sum of all assets minus the value of all non-operating assets.
Operating Assets Formula
- Operating Assets, net = Total Assets – Non-Operating Assets
Operating vs Non-Operating Assets
Unlike operating assets, non-operating assets are not considered a core aspect of operations. Even if the asset produces income for the company, the stream is considered “side income”. Marketable securities and related cash equivalents are examples of non-operating assets, regardless of the income generated by these types of low-risk investments. Financing assets are indeed assets with positive economic value but are classified as non-core assets. The monetary benefit provided by these assets comes in the form of interest income, yet a company could hypothetically continue conducting business as usual even if these securities were to be liquidated. Hence, line items such as interest income and dividends are separately broken out on the income statement within the non-operating income / (expenses) section.
Valuation of Operating Assets
Intrinsic Valuation (DCF)
When estimating the value of an asset such as a company, the valuation should isolate and reflect only the company’s operating, core assets. In the case of intrinsic valuation – most often via the discounted cash flow (DCF) model – the free cash flow (FCF) calculation should include just the inflows / (outflows) of cash from the recurring operations of the company. As a result, a company’s financials must be adjusted to exclude non-operating income, which stems from non-operating assets, and is a crucial step to accurately forecasting a company’s future performance. The projected FCFs must strictly come from the company’s recurring operations; otherwise, the implied valuation loses credibility.
Periodic Acquisitions vs CapEx
For example, the impact of periodic acquisitions should be removed, due to being one-time, unforeseeable events. On the other hand, capital expenditures (CapEx) are practically always included when calculating the FCFs of a company because PP&E purchases represent “required” spending.
As for relative valuation, the objective is to value the operations of a company based on that of its peers, also making it necessary to focus solely on the core operations to properly determine the valuation of the target. If not, discretionary decisions made by management (e.g. purchasing short-term investments) are included in the comps-derived valuation. When spreading comps – whether comparable company analysis or precedent transactions analysis – the aim should be to isolate the core operations of each company in the peer group. Doing so allows the comparisons among peers to be as close to “apples to apples” as possible.
Understand the Net Operating Assets Concept
What are Net Operating Assets?
Net Operating Assets is the difference between a company’s operating assets necessary to its core operations and its operating liabilities.
Net Operating Assets Formula
The net operating assets (NOA) of a company equals the value of all assets directly tied to core operations minus all operational liabilities.
Net Operating Assets Formula
- Net Operating Assets = Operating Assets – Operating Liabilities
As shown from the formula above, a company’s net operating assets represent the difference between its operating assets and operating liabilities. Operating assets and operating liabilities both support the continuation of revenue production from core operations.
- Operating Assets: The assets of a company required for its core operations to continue functioning (e.g. inventory and the production of products to sell).
- Operating Liabilities: The liabilities of a company that are part of the day-to-day operations (e.g. accounts payable and supplier orders).
Operating Assets and Operating Liabilities Examples
If an asset is needed for a company’s operations to continue running, it would most likely be considered an “operating asset”. And if a certain liability is necessary for a company’s operations to sustain itself, it would be classified as an “operating liability”. Examples of common operating assets and operating liabilities are as follows. An example of an asset that does NOT qualify as an operating asset would be marketable securities, which would be categorized as an investing activity. Despite the short-term investment creating income for the company, it is considered “side income” and a non-core asset unrelated to its primary operations. Further, an example of a liability that would NOT qualify as an operating liability would be long-term debt, as debt is a financing activity. The value of a company’s operating assets is equal to the sum of all operating assets less the value of all non-operating assets.
Operating Assets Formula
- Operating Assets, net = Operating Assets – Non-Operating Assets
Similarly, the value of a company’s operating liabilities is equal to the sum of all operating liabilities less the value of all non-operating liabilities.
Operating Liabilities Formula
- Operating Liabilities, net = Operating Liabilities – Non-Operating Liabilities
Net Operating Assets Calculator – Excel Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
Net Operating Assets Example Calculation
Suppose a company has $10 million in total assets and total shareholders’ equity of $7 million.
- Total Assets = $10 million
- Total Equity = $7 million
Of the $10 million in total assets, $4 million is related to financial assets such as marketable securities and short-term investments. We can subtract the non-operating assets from total assets to calculate $6 million as the company’s total operating assets.
- Operating Assets, net = $10 million – $4 million = $6 million
If the company has $1 million in outstanding long-term debt on its books, we can subtract this amount from its total liability balance. Considering the accounting equation (assets = liabilities + equity), the total liabilities must amount to $3 million given the $10 million in assets and the $7 million in equity. Once the $1 million in debt is subtracted from the $3 million in total liabilities, we are left with $2 million as the operating liabilities.
- Operating Liabilities, net = $3 million – $1 million = $2 million
Using those two values, we can subtract the operating liabilities from operating assets to arrive at the value for net operating assets, which comes out to be $4 million.
- Net Operating Assets = $6 million – $2 million = $4 million
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Enroll in The Premium Package: Learn Financial Statement Modeling, DCF, M&A, LBO and Comps. The same training program used at top investment banks. Enroll Today Sagnik b. asked • 01/15/15 Last year, our return on investment equaled 20% ; our residual income equaled $50,000, and our minimum required rate of return (cost of capital) was 12%. What were our average operating assets (rounded to the nearest thousand ) ?
A) $625,000 B) $250,000 C) $417,000 D) $333,000 E) $575,000 I believe answer was A) but I need help with steps as to how. Thanks.
2 Answers By Expert Tutors
Sam L H.
answered • 10/08/15 Knowledgeable Accounting and Finance Tutor The answer is A) 625,000 The assumption I made is that the 20% does not include the 12% cost of capital. So if the 12% cost of capital to be considered then we need a larger pool of assets to give us the $50,000 return. The way I arrived at the larger investment is by dividing 50,000 over .08 which will give you an investment pool equal to $625,000, and this is option A answer above. The 0.08 derived from 20%-12%. To test our numbers 625,000 X.20 = 125,000 Less Cost of Capital 625,000 x .12= 75,000 the residual income = 50,000 Sherryse H.
answered • 01/21/15 Accounting, Income Tax, Excel Answer: calculate Average operating assets: add (sum) ending balances for total assets for each period on balance sheet financial statements; divide the sum total by the number of statement periods during the year to determine an Average.. assume: financial statements are reported quarterly, where $625,000 = Average total assets then,
find X (sum of Total assets for the year):
X = $625,000*4
X = $2,500,000
$2,500,000 divided by 4 = $625,000 Average operating assets (RI) formula:
Residual income = Net operating income minus (Rate of return on investment*Operating assets)
Net operating income = $125,000
Residual income = $50,000
Rate of return = 12%
Operating assets = $625,000 find X (Net operating income),
$50,000 = X minus (12%*$625,000)
$50,000 = X minus $75,000
$50,000 + $75,000 = X
$125,000 = X
$125,000 = Net Operating Income ROI (return on investment): assume: net operating income is equal to net profit after taxes for this problem.. and, $125,000 = net profit after taxes, then find: ROI formula = Net profit after taxes divided by Total assets Net profit after taxes = $125,000
Total assets = $625,000
$125,000 divided by $625,000 = 20%
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