Understanding Redundant Assets: Definition & Impact on Business

Redundant assets are assets that generate incomeOperating IncomeOperating income is the amount of revenue left after deducting the operational direct and indirect costs from sales revenue. 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 activitiesRevenue StreamsRevenue Streams are the various sources from which a business earns money from the sale of goods or provision of services. The types of of the company. Redundant assets are also known as non-operating assets.

“Redundant” is possibly not the best term to describe these assets, as they are not typically duplicate assets but more so “extra” assets. The key point to remember is that they are assets that are not used as part of a company’s normal, core business operations.

When a company is being evaluated, redundant assets are excluded from the valuationFinancial Modeling and ValuationFinancial modeling and valuation is forecasting a business' free cash flow and discounting it back to its net present value at the weighted average cost of capital 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 assetsTypes of AssetsCommon types of assets include current, non-current, physical, intangible, operating, and non-operating. Correctly identifying and to facilitate the smooth operations of the company. These assets may include boats, recreational vehicles, or 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

Real estate propertiesReal EstateReal estate is real property that consists of land and improvements, which include buildings, fixtures, roads, structures, and utility systems. Property rights give a title of ownership to the land, improvements, and natural resources such as minerals, plants, animals, water, etc. 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

Marketable securitiesMarketable SecuritiesMarketable securities are unrestricted short-term financial instruments that are issued either for equity securities or for debt securities of a publicly listed company. The issuing company creates these instruments for the express purpose of raising funds to further finance business activities and expansion. 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 removed 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 activities 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 specialistsBusiness Valuation SpecialistBusiness valuation refers to the process of determining the actual value of a business. Owners work with a business valuation specialist to help them obtain an objective estimate of their business's value.They require the tap the services of business valuation specialists to determine a business's fair value, 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 may 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 estateReal EstateReal estate is real property that consists of land and improvements, which include buildings, fixtures, roads, structures, and utility systems. Property rights give a title of ownership to the land, improvements, and natural resources such as minerals, plants, animals, water, etc. 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 incomeNet IncomeNet Income is a key line item, not only in the income statement, but in all three core financial statements. While it is arrived at through 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, sellers usually remove the redundant assets from the company’s valuation.Valuation MethodsWhen valuing a company as a going concern there are three main valuation methods used: DCF analysis, comparable companies, and precedent transactions If the buyer is interested in them, then the seller must be adequately compensated for both operating and non-operating assets.

Non-Operating Income

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.

Additional Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)®™Become a Certified Financial Modeling & Valuation Analyst (FMVA)®CFI's Financial Modeling and Valuation Analyst (FMVA)® certification will help you gain the confidence you need in your finance career. Enroll today! certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

• Enterprise ValueEnterprise Value (EV)Enterprise Value, or Firm Value, is the entire value of a firm equal to its equity value, plus net debt, plus any minority interest
• InventoryInventoryInventory is a current asset account found on the balance sheet, consisting of all raw materials, work-in-progress, and finished goods that a
• Operating IncomeOperating IncomeOperating income is the amount of revenue left after deducting the operational direct and indirect costs from sales revenue.
• Real Estate Investment Trust (REIT)Operating IncomeOperating income is the amount of revenue left after deducting the operational direct and indirect costs from sales revenue.