Every commercial entity maintains a set of assets in order to generate revenues and profit for its business. The assets held by an entity can be classified into many types ranging from tangible or intangible, current or non-current and highly liquid or less liquid assets depending on their nature and usage in the business.
Based on the type of revenue they generate and the primary purpose for which they are held in a business, the assets can be segregated into two distinct types – operating and non-operating assets.
The article “operating vs non-operating assets” looks into the meanings of these two classifications of assets in more detail and explains on what ground they differ from each other.
Definitions and meanings:
Assets that are actively used to generate the main revenue and income stream for a business entity are known as its operating assets. These assets are not held for resale but are essentially needed to carry out the entity’s core operating activities and can be both tangible and intangible. They are crucial for any business and the entity cannot operate without them.
Regardless of the size and nature of their business, all commercial entities need to make enough investment in certain operating assets for efficient and successful functioning of their business. Common examples of tangible operating assets include cash, prepaid expenses, stock and inventory, furniture and fixture, equipment, motors and vehicles, plant and machinery, building and land etc.
Not only above mentioned tangible assets, but all recognized intangible assets like manufacturing and practicing licenses, trademarks, patents, computer software and copyrights etc. also make part of an entity’s total operating assets.
Entities dealing with natural resources have operating assets like fossil fuels, mineral deposits, stone, quarries, sand and timber etc. These assets are sometimes named as wasting assets or resource assets.
According to the guidelines of matching principle, the cost of all fixed tangible assets (except land which has an unlimited useful life), intangible assets and natural resources must be matched against revenues generated by using or exploiting these assets. For this purpose, a portion of the asset’s cost is allocated to expense each period the asset is used to generate revenue. This periodic allocation of asset cost to expense is known as depreciation charge for fixed tangible operating assets, amortization charge for intangible operating assets and depletion charge for natural resources or wasting assets.
Non-operating assets are the assets owned by an entity that don’t play any role in its day-to-day operations or principal revenue generating activities. Examples of non-operating assets in a business may include investment in marketable securities, loan receivable, unallocated cash, excessive land, vacant building, unused or outdated machinery and idle equipment etc. The entities list these assets in their balance sheet along with their operating assets.
A non-operating asset may generate income which is classified as non-operating income and reported separately in entity’s income statement. For example, Company A rents out its vacant building to Company B at $5,000 per month to be used as warehouse. The annual rental income of $60,000 (= $5,000 × 12) received from Company B will be reported as non-operating income in Company A’s income statement. Similarly, the interest income earned by a company from an investment which is not connected to its primary operations will be considered as non-operating income.
Non-operating incomes are not necessarily connected to the non-operating assets of a business. They may also come from other sources like foreign exchange gains etc. Non-operating assets may also raise liabilities for the business in the form of taxes payable and law suits etc.
Difference between operating and non-operating assets
Some key points of difference between operating and non-operating assets are listed below:
1. Basic meanings:
Any assets that are directly indulged into an entity’s typical day-to-day operations are termed as operating assets. These are named as operating assets because they form part of the regular operating cycle of entity’s business. However, non operating-assets are extra assets of a business. Such assets are not utilized in the main turnover generation, but may be used on short or long term basis to produce some extra revenues for the business. A business entity may decide to invest in these assets for future endeavors. These assets are considered as redundant assets until the entity uses them in its regular operations in future.
2. Responsibility and accountability:
Management is directly responsible for their duties in relation to operating assets as these are the assets they utilize in order to carry out their strategic tasks. These assets make part of the performance evaluation process of an organization. Non-operating assets, on the other hand, are normally managed instead of their active utilization in business. Larger organizations normally appoint an expert to manage and optimal use of their non-operating assets. That expert is responsible for the effective management of non-operating assets and held accountable in this regard. In small to medium sized organizations, either management directly manages non-operating assets or this service is outsourced.
3. Revenue and profit projections:
Operating assets determine the production and sales capabilities of a business entity and are essentially considered in revenue and profit projections. Non-operating assets don’t have an active role in core business operations and are therefore ignored while making these projections.
4. Decision making:
Managers directly consider operating assets into their decision making process because these assets are primarily connected with the typical operating activities of a business entity and directly impact its financial and non financial status. On the other hand, management does not consider non-operating assets while making key financial and non-financial decisions of the business because they do not play any direct part for the strategic success of a company. However, income driven from these assets is added within the net profit and makes part of the entity’s retained earnings which directly increases its equity portion.
5. Types of revenue and income:
The revenues and income generated by making use of operating assets are known as operating revenues and operating income respectively. The operating revenues are reported at the top of income statement. Any revenues or income brought in by using non-operating assets is named as non-operating revenues and non-operating income. The non-operating revenues are not mixed up with the entity’s regular or operating revenues but are separately reported in a different section known as “non-operating or other revenues” near the bottom of income statement, typically just above the income tax expense.
All assets that support an entity’s primary or basic business operations are examples of non-operating assets. They typically include tangible assets like plant, machinery, equipment, office furniture, computers, cash and recognized intangible assets like licenses required to practice or manufacture products, patents and copyrights. All assets that a business entity holds but does not use in its primary or basic operations are examples of non-operating assets. They typically include vacant land, empty buildings, idle equipment, outdated or useless machinery and long term debt or equity investments that are no related to entity’s normal operations.
Operating vs non-operating assets – tabular comparison
A comparison of operating and non-operating assets in tabular form is given below:
|These assets are included within the normal operating activities of business.||These assets are not included within the normal commercial activities of business.|
|Responsibility and accountability|
|Management and other operational workforce is responsible and is held accountable for the effective utilization of these assets.||Only those management personnel are responsible and held accountable who directly manage these assets.|
|Revenue and profit projections|
|Considered for these projections||Not considered for these projections|
|The management actively considers performance of these assets within their decision making process.||The management does not consider these assets while making key business decisions.|
|Types of revenues|
|Are responsible for generating operating income for a business.||These assets are either redundant or produce other income such as rental, dividend, interest income etc. for a business.|
|Tangible: office building, factory building, operational plant, machinery, working tools, equipment, cash etc.
Intangible: licenses, patents, copyrights etc.
Natural resources: coal, minerals, sale, timber etc.
|Long term investments, empty buildings, vacant tract of land, outdated machines etc.|
Conclusion – operating vs non-operating assets
The revenues of an entity may come from many sources, and among these, the revenues and profits from primary operating activities are of utmost importance because they make up a larger portion of entity’s overall revenues and profit. A proper understanding of the difference between operating and non operating assets is important to know the amount of revenues and profit contributed by each type of assets and may help in improving entity’s productive efficiency.
Generating profitable revenues on continuous basis using the least amount of operating assets is considered a sign of good management.
Although non-operating assets are not connected with an entity’s core operations, they can provide diversification against operational risks. If properly managed, non-operating assets can generate revenue which can act as financial backup in case the entity loses money in its core operations.