For generating earnings, a company requires different assets. While some of these assets are useful in the short term, others are useful in the long term. The latter is referred to as non-current assets, which help the company generate earnings in the long run. In any company's balance sheet, you will find a separate section for these assets.
In this article, we will help you understand non-current assets meaning, how they work, their importance, and a lot more insights into these assets.
- What are non-current assets?
- Components of non-current assets
- How to calculate non-current assets?
- How to acquire non-current assets?
- Which financial ratios depend on non-current assets?
- Why are non-current assets important to the company and the investors?
- Conclusion
What are non-current assets?
The non-current assets meaning can be stated as assets which are acquired for future developments of the business. These are highly illiquid assets that cannot be easily converted into cash within one account year. These assets are acquired as long-term investments into the business. Some non-current asset examples can help you better understand these assets. These are pieces of machinery, land and property, intellectual properties and similar assets.
Components of non-current assets
To understand the non-current assets meaning better, knowing the components of non-current assets will help. The components include –
- Tangible assets: These are assets which are in physical form and have a definite value as well. Tangible assets of a business can be pieces of equipment that the company requires to produce the products or render the services. These assets also include plants where the products are manufactured or the office premises which are used by the business. This component of non-current assets having a definite value needs to be amortized over time or depreciated as tangible assets' value is used over time. Due to wear and tear, the value depreciates. However, not all tangible assets depreciate, for example, land. The value of land will not depreciate until and unless the land is affected by some natural disaster or man-made disaster. Another aspect of these assets is that they form the base of the operation of the business.
- Intangible assets: The next component is intangible assets which include goodwill, patents, rights, and intellectual properties. At the same time, these assets do not have any physical form but have economic value. While tangible assets have a limited shelf life, that is, they can be used for a particular period, intangible assets may or may not have a limited shelf life. For some intangible assets, the shelf life can be limited, while for others, it can be indefinite.
- Natural resources: Finally, there are natural resources which also comprise the non-current assets of the company. However, these assets do not form a part of every business. These are specific to businesses which are involved in mining, minerals production, and oil production, basically where natural resources are used, which are obtained from mother earth.
How to calculate non-current assets?
To derive the value of non-current assets of a company, you need to sum up all the tangible, intangible and natural resources of the company. Let's understand this using an example of non-current assets:
Suppose there is a company which has equipment and machinery worth ₹100 crores and depreciation to date is ₹10 crores. The plants they have are worth ₹500 crores. Their goodwill value is ₹ 15 crores, rights and patents worth ₹ 20 crores and the natural resources they use worth ₹1000 crores.
So, the total non-current asset valuation would be = ₹ {(100-10) + 500 + 15 +20 +1000} = ₹ 1625 crores.
How to acquire non-current assets?
Now let's understand how a company acquires non-current assets. As these assets provide value over a long span and for future periods, the company uses funding options that they can avail for a long tenure. Usually, the financing options include term debts, commercial loans, capital leases, and reducing term loans. The other option is equity funding where the company raises capital from the public to invest in these assets as the same will help in future growth and expansion of the business.
Which financial ratios depend on non-current assets?
Information related to non-current assets is vital and used by the company as well as the investors. The valuation of these assets is used for determining some of the key financial ratios, some of which are:
- Non-current asset turnover ratio: This ratio depicts the revenue generated by the company in relation to the net book value of the non-current assets. This suggests whether these assets are being used optimally or not. To derive the ratio, one needs to divide the company's net sales revenue by the net book value of the non-current assets.
Non-current asset turnover ratio = Company's Net sales revenue/company's net book value of non-current assets
- Non-current assets to net worth: This ratio helps understand how the company has invested in these assets with low liquidity. This can be derived from the following:
Non-current assets to Net worth = Non-current assets / Net worth of the company
Why are non-current assets important to the company and the investors?
The value of non-current assets and the ratios mentioned above are used by the company as well as the investors for –
- Analyzing the financial performance and overall performance of the company
- The ratios help the investors understand how well the company is managing its assets and how much profit they are making by using these assets optimally
- This also helps in analyzing different competitors or doing peer analysis
- It helps the company understand which assets are providing value and which have reached their end of shelf life.
Conclusion
The assets are the backbone of any business, and non-current assets form the pillar for the company's future. Though these assets cannot be turned into quick cash, they are there in the business to run the operation and generate value over time. For every investor, it is equally important to understand how the company is using its non-current assets to generate value to evaluate the management's capabilities and the prospect of the company.