Understanding Assets and Liabilities

3 min read

What are the assets and liabilities? Assets are owned by the business while liabilities are owed by the business. Both assets and liabilities decide the company’s financial health. Anyone can get a clear picture of the business by considering the assets and liabilities it owns. Assets provide future benefits to the company. Not only in businesses but also the day to day life, you have assets and liabilities.

Assets

An asset is the resources owned or controlled by a company, individual, corporation, or government with the expectation to create positive economic value using it. You can control the assets. The assets are generated as a result of a past event. They have future economic benefits. We will use a small example to understand assets. You are making lunch for the family. The rice cooker, pans, and burner are your assets.

Assets have been classified into several subcategories. All the assets in your company come under these categories.

Assets are two types as fixed assets (Long-term assets) and current assets (short-term assets). Current assets are easily convertible into cash. Those are important for small businesses. Small business can survive for a long period without borrowing money. Cash, inventory, and marketable securities the examples for current assets.

The other type is “Fixed Assets”. They last for over a year. It adds value to the company. A fixed asset cannot be converted to money easily, just like current assets. Buildings, lands, furniture, and vehicles are included in fixed assets.

There are other classifications for assets. It is tangible assets and intangible assets. You can touch tangible assets. Those are physical objects. Vehicles, cash, and buildings are tangible assets. You can’t touch intangible assets. They are not physically present. But intangible assets have financial value as same as tangible assets. Brand name and reputation come under intangible assets.

“Operating assets” are used to generate and to maintain the day-to-day operations of the business. The building, office equipment, cash, and stocks are examples of operating assets. The other type is “Non- operating assets”. It is referred to assets that are not used to perform daily operations of the business. Assets that generate significant revenue such as the interest for fixed deposits, vacant land, and short- term investments are examples for non-operating assets.

Liabilities

Liabilities are defined as an obligation arising as a result of a past business event. Liabilities are owed by the business. It can be either now or the future. The business needs to fulfil these obligations. Simply liabilities refer to credit. These obligations are created as a result of past events. When settling these obligations, the outflow of valuable resources of the organization takes place. Liabilities are mainly two types. Those are internal liabilities and external liabilities. Employee salary is an example of internal liability, while creditors and taxes are examples of external liabilities.

Liabilities are categorized into two types as current liabilities and long-term liabilities. Current liabilities need to be paid within a year. Business expends more on current liabilities. Salaries, bank overdrafts, credit lines, and short term bank loans are examples of current liabilities.

Long term liabilities can be settled after a year. Or, in other words, financial obligations that do not need to be settled during the regular business course. Capital leases, mortgage debt, Long term loans, debentures are examples of it.

The Difference between Assets and Liabilities

Understanding the difference between assets and liabilities is important for a business owner. The number of assets must be more than the number of liabilities available in the business. More assets show the ability of the business to pay its debts. Debtors are also a liability. If the business is unable to fulfil debts, the company is in financial trouble. These liabilities can be either money owed or services that need to be completed.

Importance of assets and liabilities

Assets and liabilities help to identify the liquidity ratio of a business. It will help to analyze the company’s effectiveness to convert assets into cash or cash equivalent readily. Assets and liabilities help to ensure the profitability and sustainability of the business.


By knowing the assets and liabilities number of ratios that are important to the business can be found easily. The acid-test ratio, current ratio, debt ratio, owner’s equity, and cash ratio can be found quickly. The ratio values determine the company’s standing debts, its ability to pay existing debts, repay short- term liabilities, and many other important facts.


Investors gather information about the assets and liabilities of a business before investing. So it is important to aware of the assets and liabilities of your business before seeking investors.

We shall consider the assets and liabilities of some businesses to get a better understanding.

  • A car seller

Assets:
Cars, Car selling orders that have already got, Place used to park cars. Savings account of the business


Liabilities:
A bank loan is taken for getting cars, Salary for staff, Taxes owing, utility bills

  • An insurance Company

Assets:
The building, computers, company vehicles, office equipment like telephones, fax machines, and photocopy machines, and office furniture like desks and chairs

Liabilities:
Income tax payables, lease agreements, unearned revenue

  • A Clothing Store

Assets:
Land, building, stock, delivery vehicles, brand name


Liabilities:
The bank loan, employee’s salary, telephone bills, and water bills, government taxes, insurance payable, accrued liabilities

  • A coffee shop

Assets:
Coffee machines, equipment like chairs and tables, unique recipes,

Liabilities:
Rent for the shop, bank loans, utility bills, salary of the waiters


Think about yourself the laptop or the mobile you are using to read this article is an asset for you. The internet bill that you have to settle at the end of the month is a liability. It is easy to figure out liabilities and assets in your everyday life. But you need to focus well to separate liabilities and assets in a business. The balance sheet reflects the business’ financial position. So it would help if you considered both assets and liabilities of your business.

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