Holding idle #fixed assets or inventory typically gets waived as being fairly irrelevant. What is wrong with using a #machine beyond its useful live if it still works, or why should we get rid of that machine that is infrequently used but still works.
There are a couple of things we need to consider when looking at assets:
- Why do you have an asset in the first place?
- What is your expectation of the assets, how much #return do you want it to generate?
- Are my idle and fully depreciated assets generating a return higher than the #cost of employing them?
- Do I employ assets that go beyond their useful life? Why?
- What is the cost of maintenance to keep depreciated assets in production?
- How much space are my idle fixed assets taking in place?
What is often forgotten is that the asset utilization diminishes over #time, meaning that the cost to maintain the assets becomes more expensive (exceptions there of course). It is advisable to have a total maintenance program in place where you assets are frequently reviewed for maintenance and that those that are beyond their useful life get sold, for what they are worth.
#return on assets = Net Income / Total (Gross*) Average Assets
*I prefer to use the Gross Assets (ROGA) value to look at assets as it takes into #account the capital you have employed. It gets the focus of the #management to get rid of assets that do not generate a return.
Now why is it so important to make sure that you employ assets that generate a high enough return. Lets use the following exercise. Two companies in the same industry, similar #performance but less assets:
- Assets Value: 50M
- Net Income: 2M
- ROA: 4%
- Assets: 25M
- Net Income: 2M
- ROA: 8%
It is clear that in this example something is wrong. You would expect that if a company with 25M of assets would be able to generate a return of 2M, a company with 50M of assets would surely earn double (assuming there is enough market). Is CapIntense investing in the wrong fixed assets?
Assume that of CapIntense 50 assets, 25 of them would be generating a return of 0.5M net income, the other 25 assets would be generating 1.5M net income. Wouldn’t this company be better off in getting rid of the 25 assets that generate a return of “only” 0.5M and replace them by the productive high yielding assets. If they would do that they would earn a 8% return on their assets as well and be in line with their peers.
In summary, holding idle assets is a waste of space, will cost you in servicing and maintenance and most importantly you could have earned a higher return if you employed an asset that would generate a higher return.