Which of the following would be considered an operating asset in return on investment computation?

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)
• Inventory
• 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.

Relative Valuation

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.