In estimating the fair market value of a business, the valuation analyst must consider, and adjust for, nonoperating and excess assets. Non-operating assets are defined as those assets that are recorded on the company’s balance sheet that are unrelated to the operations of the business. An example of a nonoperating asset would be a condominium in Stowe, Vermont that is owned by a company and used exclusively by the principles in a manner totally unrelated to the operations of the business. Excess assets are defined as those assets that are not required in the operations of the business. An example of an excess asset might be cash and/or marketable securities which are not needed to run the business.
Now that non-operating and excess assets are defined, the next step for the analyst is to locate them. There are generally two sources. One source is the company’s depreciation schedule and the other source is the company’s balance sheet. The analyst would use the company’s depreciation schedule to locate nonoperating assets. The depreciation schedule shows the fixed assets owned by the company, which includes buildings, transportation equipment, equipment, furniture and fixtures, etc. The company’s balance sheet shows a breakdown of assets owned as of a certain date. One of the categories on the balance sheet is cash in bank. Other categories on the balance sheet to review are other current assets and other assets. These categories might reflect marketable securities, CD’s, etc.
Once non-operating and excess assets have been identified, the analyst needs to quantify them. Nonoperating assets should be valued by experienced appraisers and recorded at their fair market values. Keep in mind that if the non-operating asset has an accompanying liability, it also must be recorded at its fair market value and will offset the non-operating asset. To use the previous example, if the condo in Stowe has a mortgage recorded on the company’s balance sheet, the mortgage amount would need to be netted against the asset.
To quantify the amount of excess assets, the analyst would interview management and use ratio analysis.
Let’s say the company being valued is a restaurant, maintains no accounts receivable, owes $10,000 to vendors (accounts payable), is very profitable and maintains a cash balance of $200,000. The analyst would interview management and question why there is such a large cash balance. If the answer is that
$180,000 is needed for major renovations, then there would be no excess cash. If there was not a valid business reason why the cash was being accumulated, the analyst would then determine, using ratio analysis, whether the cash balance includes excess cash. One way the analyst would determine the amount of excess cash using the above example is to (1) Determine the average current ratio in the industry. Let’s say it is 2:1. This means that the average company in the industry has $2.00 in cash for every $1.00 in accounts payable. (2) Apply this ratio to the accounts payable of the subject company to determine an appropriate amount of cash. In this example, accounts payable of $10,000 would be multiplied by 2 to determine the appropriate amount of cash, which is $20,000. (3) The $20,000 calculated in step (2) would be subtracted from the company’s cash balance of $200,000 and the result of $180,000 would be considered excess cash.
Once the non-operating and excess assets have been identified and quantified, the analyst would add back or subtract the income or loss generated from these assets in arriving at the Company’s normalized net income or normalized net cash flow. In the above examples depreciation on the condo in Stowe would be added back and interest income on the excess cash would be subtracted in determining the company’s normalized income or cash flow.
Once the analyst determined the value of the business, he or she would add back any non-operating and excess assets in determining its estimated fair market value. This is because those assets, while not necessary to operate the business, are still owned by the business and constitute a component of entity value.
Please see our website for an example of handling non-operating and excess assets.
Example:

XYZ Company owns a successful breakfast franchise. There is no accounts receivable. The Company has
$400,000 in cash, which is the average balance for the year. The cash generates interest income of $10,000 for the year. The Company owes $20,000 in accounts payable and sales tax. The Company owns a condo in Stowe, Vermont that cost $100,000, has accumulated depreciation of $40,000 and current year depreciation of $10,000. The condo has a fair market value of $200,000. There is no mortgage on the property.
The following are normalization adjustments to the income stream that should be made:
1.
We determine that the Company needs to maintain a cash balance of $50,000. Therefore, there is
$350,000 in excess cash. We would subtract $8,750 from the income stream because this amount represents interest income on an excess asset.
2.
We would add back $10,000 in depreciation charges because the condo is a non-operating asset.
The following are adjustments that need to be added to the value of the business in determining its fair market value.
1.
$350,000 in excess cash needs to be added back because it would not be included in a sale.
2.
$140,000 would be added back to the value of the business. This adjustment is calculated as follows: The book value is calculated to be $60,000 ($100,000 - $40,000). The fair market value of the condo is $200,000. The adjustment would be $140,000 ($200,000 - $60,000).