In the last article, we have seen what assets are in the balance sheet of the company, its classification and also we discussed current assets in detail. In this article, we are going to talk about non-current assets.
Non-current assets are also known as long term assets. A company may purchase an asset and use it for a number of years. In such a scenario, it allocates the cost of assets over the number of years for which it will use the asset instead of allocating the entire cost to the accounting year in which the asset was bought by the company. Based on the type of asset, it will be categorized as amortized, depreciated or depleted.
Depreciation allocates or spreads the cost of a tangible asset over its economic useful life. You can understand it as a reduction in the cost of fixed assets due to wear and tear, day to day usage. Depletion is a systematic reduction in the value of natural resources, it allocates the cost of extracting natural resources, such as minerals, timber, and oil from the earth. While amortization is the deduction of intangible assets over a specified time period which is typically the life of an asset.
Companies classify investments as non-current only if they are not expected to turn into unrestricted cash in the next 12 months of the balance sheet date. Companies purchase non-current assets with the intention of using them in the business since their benefits for them lasts for many years.
Non-current assets classification
The non-current assets are mainly divided into 3 types - tangible, intangible and natural resources. The tangible assets are depreciated, intangible assets are amortized and natural resources are depleted.
Tangible Assets - Tangible as we know means something which can be touched or is physical. So tangible assets are in physical form and have a finite monetary value. Companies calculate the value of tangible assets by taking the current value of the asset less depreciation. Some examples of tangible assets are building, inventory and machinery.
On a balance sheet, tangible assets are usually given as Property, Plant and Equipment (PP&E) which are used in the production or sale of other assets. There is a cost of PP&E which includes all expenditures like insurance, installation, broker cost, transportation, search cost, a legal cost that are necessary to acquire and ready them for use.
Intangible Assets - Intangible assets lack a physical form but offer economic value to the company. Intangible assets can significantly contribute to the long-term success of a company even though it lacks physical value. Some of the intangible assets are goodwill which is attributed to buying some intangibles, such as the reputation of the company, a solid customer base, good customer relations, brand name, and the quality of the employees and intellectual property such as patents, copyrights and trademarks.
Intangible assets can further be divided into two types - definite and indefinite. An indefinite intangible asset is brand recognition which remains for as long as the company stays in business. A definite intangible has a limited life and is associated with the company for the duration of the agreement or contract.
Natural Resources - These include assets that occur naturally and are derived from the earth. Examples of natural resources are timber, oil fields, fossil fuels, and minerals. These are also referred to as wasting assets since they are used up once they are consumed. Natural assets are shown or projected on the balance sheet at the cost of acquisition plus exploration and development costs and less accumulated depletion.
Long Term Investment - Long term investments include assets such as bonds, notes, stocks that investors buy in the financial market hoping that the price of these assets will appreciate in value in the future and earn a good return.
Other non-current assets - Some companies in their financial statement, under non-current assets, show 'Other assets'. Different assets will come under 'other assets' depending on the company and its sector. Some examples of 'other assets' are cash surrender value of life insurance, unamortized bond issue costs, etc. When compared to total assets if 'Other assets' is significant then you may have to check what it means. Usually, analysts get to the company's management when the ratio is higher to know what exactly ‘other assets’ cover.
Understanding Non-Current assets of Reliance
In the last article, we have seen the current assets of Reliance as of 31st March 2020. You can check the non-current assets under the asset section on their balance sheet -
As you can see, under non-current assets, the company has reported Rs 2,97,847 crores under Property, Plant and Equipment (PP&E) assets. When divided to the total non-current asset, it comes out to be 37% which is a good ratio of PP&E and total non-current asset. A high PP&E signals that management has faith in the long-term outlook and profitability of the company. Since it is a tangible asset it is expected to generate economic benefits and contribute to revenue for many years. You also see an asset 'Capital work in progress'. This is not applicable to all companies. In the case of Reliance, it represents the cost incurred to date on a fixed asset which is still under construction.
The other non-current assets we have discussed above and you can easily understand them - Intangible assets stand at Rs 8,624 crores, Financial assets are divided into Investments and loans which accounts for Rs 4,19,073 and Rs 44,348 crores respectively. The ‘other non-current assets’ are only Rs 4,458 which is negligible compared to total non-current assets. As discussed above, if it is a small percentage of the total, you as an investor should not worry about it.
Importance of Non-current assets
Non-current assets tell that the earning by the company is giving worthwhile return from the wealth tied to the business. The amount of capital under non-asset is industry specific, the capital-intensive industries usually have a large percentage of their asset base consisting of non-current assets. Reliance is a perfect example for it. On the other hand, service based companies may require minimal to no use of fixed assets. A high proportion of non-current assets to current assets may indicate poor liquidity, this may also simply be a function of the respective company’s industry.
Hope after reading this article, when you check the balance sheet of any company, it will look a lot familiar and you will be able to understand the numbers in different categories.
- The company is trading (Rs. 2332.45) above its fair value (Rs. 1665.82), which is a good sign to sell/hold, its fundamentals(balance sheet, income statement, and cash flow statement) are above average (3 out of 5).
- That’s why Stockylab has a sell call with 47% confidence, hold with 28% confidence and buy with 23% confidence.