Assets and Liabilities: What Common Man Should Be Aware of?

Assets and liabilities are important components of every business. People involved in business must understand the concept of assets and liabilities as they are often used to represent the financial standing of any business. Let’s make a comparative analysis of the two to understand how important they are to a business:

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What are Assets?

While discussing assets, first let’s try to grasp its concept and how it functions in a company’s balance sheet.

See Also: What are Fixed Assets?

Assets are the resources that help businesses generate profit. These resources are owned by the company and thus the business has control over them. Here are the factors that resources need to possess to become an asset:

• It must give economic benefit in the future
• It is something over which the company has control

Assets can be further subdivided into two categories:

Current Assets: Assets that can be feasibly converted into cash within 1 year are known as current assets. Assets that can be listed under current assets include cash and cash equivalents, inventory, short-term investments, liquid assets, etc.

Fixed Assets: Fixed assets are the resources that are held for more than a year. These assets have a financial value to the business they belong to. For example, machinery or transport used in a business can be considered as fixed assets.

Thus companies depend on their current asset reserves to pay off their current obligations and fund their operations. On the other hand, the fixed assets are the liabilities of a company that lasts for several years. These cannot be quickly converted into cash.

See Also: What are Intangible Assets? How Does it Work?

What are Liabilities?

Liabilities, on the other hand, are the obligations that businesses must fulfill. The most common business liabilities come in the form of accounts payable, where the business needs to make payments to the suppliers.

All business has liability and thus liabilities can be further classified into two types:

Current Liability: Current liabilities are those that must be repaid within a year. Common liabilities include salaries, account payable, loans and credit lines.

Long-Term Liability: These are the financial obligations of a business that are due for over a year. These are also known as non-current liabilities as they will not be paid within the next 12 months from the balance sheet date. This kind of debt is often used to understand the company’s capital structure.

See Also: How Rich People Build Assets?

Assets vs. Liabilities: What Common Man Should Be Aware of?

As we have already discussed, assets and liabilities are the two important entities in a company’s balance sheet. Assets are the things sorted based on their liquidity whereas liabilities are sorted on the basis of their payment schedule. Let’s try to examine the key difference between the two:

• Assets are the items that bring profit to the business. They help in the manufacturing process, provide services and have a future value. But, liabilities are the obligations of the company. Liabilities can be in the form of financial obligations or the services that will be performed in the future.
• Both assets and liabilities are important components of a company’s balance sheet. However, there is a third component mentioned in the company balance sheet. Assets appear on the left side of the balance sheet whereas liabilities appear on the right side. The third component known as shareholder’s equity is used to balance the equation. Thus total assets subtracted by total liabilities are used to represent the shareholder’s claim to the company at a given point.
• A company must have more assets than liabilities. Having more assets means the company has enough liquidity to pay off its dues. If a business has more liabilities than assets, it will not be able to pay its obligation and may end up in financial trouble.
• Although, liabilities are the financial obligation they are not necessarily bad. They can often help businesses to grow. For example, if a company is under financial obligation for the purchase of machinery or tools then the tools help the business expand its operations. Thus this is a positive thing of the business. However, the business must restrict its liabilities and must refrain from growing it faster than its assets.

See Also: What are Asset Classes? Types of Asset Classes

Understanding Assets and Liabilities Through an Example:

People operating a small business must understand the concept of assets and liabilities to get an idea of the company’s financial standing. Here is an example of a home-painting business:

Assets of the business: painting equipment, savings in the bank account, office furniture and equipment (computer and printers), vehicles and painting contracts.

Liabilities: salaries to staff, painting supplies bought on credit, business loan to purchase an office building, taxes on income, insurance, and benefits payable to staff and unearned revenue.

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