Non Current Assets
October 19, 2020
What is a Non-Current Asset?
Non-current assets often represent a significant proportion of the total resources controlled by a company. They are recorded in the balance sheet and held into the long-term by the business, with the intention of producing long-term economic benefits. Companies categorize assets as non-current if they expect them to be converted into cash, consumed through business operations or discharged for longer than 12 months.
Key Learning Points
- Non-current assets often represent a significant portion of a company’s resources and can be categorized into tangible and non-tangible
- PP&E and intangibles are stated net of accumulated depreciation and amortization respectively
- Depreciation is a non-cash expense and represents the consumption of benefits of a tangible asset over time
- Amortization is the same as depreciation, but represents the consumption of intangible assets
- EBITDA is a widely used measure of profitability EBITDA without taking the cost of tangible (depreciation) and intangible assets (amortization) into account. This is particularly useful when analyzing capital intensive companies e.g. oil and gas
Tangible vs Non-Tangible
Tangible assets are physical in nature such as property, plant and equipment (PP&E). Their economic cost is allocated over their useful life in a process called depreciation. They are reported at initial cost in the balance sheet, and expensed through the income statement for each year of their use (depreciation expense).
Intangible assets include goodwill, patents and licenses and are resources controlled by the entity with no physical substance. They too are allocated across their useful life but using a process called amortization. These assets are typically harder to accurately value with patents being a common example. The value of the patent is hard to establish so there are complex rules governing when you can and can’t put them on the balance sheet.
Non-Current Asset Metrics
Many items we see regarding non-current assets, such as capex, accumulated depreciation and gross PP&E, can help analysts measure the financial performance of a company and indicate where the company is heading in the future. Let’s take a look at some of the most widely used metrics:
Capex Ratio
= Capital expenditure / Sales
The capex ratio measures the investment relative to company sales. An increase in this ratio over time would suggest future growth. If a company continues to invest in resources through increase in capital expenditure, then we would expect to see an increase in sales the following year. This pattern of continuous reinvestment of retained earnings year after year is what drives company growth and enterprise value.
“Capital expenditure (capex) can be broken down into expansion capex and maintenance capex. Expansion increases overall capacity (increase in non-current assets net) whereas maintenance simply keeps the existing activity levels operating effectively.”
Excerpt from our bestselling Analyst & Associate Guide
Average Age of PP&E
= Accumulated depreciation / Gross PP&E
The average age ratio appraises the age of the asset (in this case PP&E) and shows the average age of assets. By measuring accumulated depreciation relative to the gross value of the asset, we can see how “old” the asset is as a percentage of its total life. A high ratio would suggest that much of the asset’s life has already been used, and the business faces an “ageing asset base”, which will require investment.
Reinvestment Ratio
= Capital expenditure / Depreciation
The reinvestment ratio (sometimes referred to as the replenishment ratio) compares capex to depreciation and is an interesting indicator of the extent to which enough investment is being made into assets. In other words, are depreciating assets being replaced? Often this ratio is expressed as a multiple and a financially healthy business should expect this multiple to be greater than 1. Due to inflation, assets purchased many years ago will cost more to replace if purchased today. Depreciation is calculated at historical costs so should be a cause for concern if this ratio was hovering close to exactly 1. This would suggest that the business is not replacing old assets effectively.
All these ratios are very useful when measuring the performance of a business. Analysis can be conducted on many components of non-current assets to provide a lot of useful information into how the business is operating and managing its long-term assets.
Access the free download to see how to calculate the asset ratios using the information on sales, capital expenditures, depreciation, accumulated depreciation, and net PP&E.