Assets and Liabilities

Assets and liabilities are crucial for a business's profitability and long-term viability. The way a company manages them is vital. Assets are what a company owns, while liabilities are what the company owes. Both assets and liabilities are shown on a company's balance sheet, representing its financial health. The disparity between a company's assets and liabilities determines its equity.

What are assets?

Assets have different meanings in different concepts, depending upon the terms where you use them. In finance, assets are resources that have financial value for an individual, company or country. For example, in accounting, owned office property is an asset of a company. In emotional terms, a hard-working employee is considered an asset for the company even though the employee is on salary.

The things that you own or the investments that you have made are your assets. Below are some of the assets that you must be aware of:

• Cash
• Investments
• Patents
• Property
• Receivables
• Stocks

The assets are categorised into different types depending on their physical presence, usage and value.

Also read: What is an asset class

Different types of assets with examples

Listed below are some details about different types of assets with examples:

1. Current assets
   You might have seen the word current assets mentioned in balance sheets. These assets are equivalent to cash and can be easily converted into cash through sales or liquidation within a year. Current assets include cash, inventory, account receivables, cash equivalents and short-term investments. These assets are essential for business, as they can be easily converted into cash, to support ongoing business operations. These can be used for paying bills and expenses of day-to-day activities.
2. Non-current assets
   It takes time to convert non-current assets into cash. These are long-term investments such as land and machinery. These assets are revalued by considering amortisation and depreciation. For example, Machinery loses its value every year due to constant usage. Due to this, it is necessary to consider the depreciation of the machinery every year. Land, long-term investments, Patents, manufacturing plants, and machinery are Non-current assets. Current assets and noncurrent assets are also further classified into tangible and intangible assets.
3. Tangible assets
   The assets that are visible to your eyes, such as lands, machines, cash and stocks are known as tangible assets. These assets have financial value but have no physical presence.
4. Non-tangible assets
   The assets that have financial value but no physical presence are classified into intangible assets. Some examples of intangible assets are patents, goodwill, trademarks and brands. 
5. Operating assets
   Operating assets are resources a company uses in its day-to-day operations to generate revenue. These include cash, inventory, accounts receivable, and machinery. They are essential for the core activities of a business, directly contributing to its income and operational efficiency.
6. Non-operating assets
   Non-operating assets are resources not essential for a company's primary business activities. These include investments, idle equipment, and real estate not used in operations. They do not directly contribute to the company's core revenue generation but can provide additional income or serve as financial reserves.

The most commonly used forms of investment by the majority of people are mutual funds and fixed deposits. Bajaj Finserv Platform offers a range of options for fixed deposits and mutual funds. You can select from the available choices based on your specific requirements. To determine the value of your assets you also need to consider your liabilities. The balance between assets and liabilities determines the financial condition of your company. Let’s understand more about liabilities.

What is liability?

Liability is when you owe something to someone. In financial terms, the debts that you owe are your liabilities. For example, If you buy a house and take a home loan, the house is your property and asset, while the loan you need to pay is your liability. Some forms of liabilities are loans, mortgages, bonds, deferred payments and accounts payable.

Different types of liabilities with examples

Listed below are different types of liabilities with examples:

1. Current liabilities:

Loans that need to be repaid, within a year are known as current liabilities. These debts are settled using the revenue generated from the day-to-day operations of your company. Current liabilities are short-term loans, accrued expenses, tax payable, payroll, dividends and accounts payable. Some liabilities examples are overdrafts from banks for boosting capital, employee benefit plans such as medical claims and advances received before delivery of a product or service are considered current liability.

2. Non-current liabilities:

Liabilities that are not due within a year are non-current liabilities. You don’t have to pay these liabilities within a year. These liabilities are assessed every year in the balance sheet. Long-term investors look into the non-current liabilities of a company to understand its financial condition. Some non-current liabilities are long-term borrowings, leases, bonds payable, secured and unsecured loans and deferred tax liabilities. Liabilities examples are paying a long-term lease for your manufacturing unit. It is a non-current liability.

3. Contingent liabilities:

Contingent liabilities are the potential liabilities that may arise in future as lawsuits or product warranties. Contingent liabilities are recorded in the balance sheet to ensure the financial reports are accurate. It is considered a generally accepted accounting principle. For example, the company cannot plan for the products that will get replaced under warranty. They have no prior knowledge about the number of products that will be replaced or returned. This type of unexpected outcome is counted under contingent liabilities.

Difference between assets and liabilities

Assets are resources owned by a company or individual that are expected to provide future economic benefits, such as generating income or holding value. On the other hand, liabilities represent financial obligations or debts that a company or individual must settle, which may involve the outflow of resources or services. Check out the key differences between assets and liabilities in the comparison table below:

Understanding your financial health: Assets vs. Liabilities

Your financial well-being hinges on a healthy balance between your assets and liabilities. Here's why:

• Net worth: The difference between your assets and liabilities represents your net worth. A positive net worth indicates your financial strength – the more assets you own compared to debts, the better.
• Financial stability: A balanced relationship between assets and liabilities promotes financial stability. Having sufficient assets readily available allows you to meet your financial obligations and weather unexpected situations.
• Debt management: Managing debt effectively is crucial for a healthy financial position. When your assets significantly outweigh your liabilities, you have greater flexibility in managing debt repayments and avoiding excessive borrowing.

Maintaining a healthy balance between assets and liabilities empowers you to:

• Make informed financial decisions: A clear understanding of your financial situation enables you to make informed choices regarding investments, loans, and financial goals.
• Prepare for the future: Building assets over time strengthens your financial security for future needs like retirement or emergencies.
• Achieve financial goals: A healthy asset-to-liability ratio allows you to pursue your financial aspirations, such as buying a home or investing for your future.

Relationship between assets and liabilities through financial ratios:

The relationship between assets and liabilities is fundamental to understanding a company's financial health, often assessed using financial ratios. Key ratios include:

1. Current ratio: This ratio measures a company's ability to cover its short-term liabilities with its short-term assets. Calculated as current assets divided by current liabilities, a ratio above 1 indicates that the company has enough assets to meet its short-term obligations, reflecting good liquidity.
2. Quick ratio: Also known as the acid-test ratio, this ratio provides a more stringent measure of liquidity by excluding inventory from current assets. It is calculated as (current assets - inventory) / current liabilities. A higher ratio suggests better financial health and immediate solvency.
3. Debt-to-equity ratio: This ratio compares total liabilities to shareholders' equity, indicating the proportion of equity and debt the company uses to finance its assets. A high ratio suggests a company is heavily leveraged, which can imply higher financial risk, while a low ratio indicates lower risk and greater financial stability.
4. Asset turnover ratio: This efficiency ratio measures how effectively a company uses its assets to generate sales, calculated as net sales divided by total assets. A higher ratio indicates more efficient use of assets.
5. Return on Assets (ROA): This profitability ratio shows how effectively a company uses its assets to generate profit, calculated as net income divided by total assets. A higher ROA indicates more efficient asset utilization.

By analysing these ratios, stakeholders can gain insights into a company's operational efficiency, liquidity, and financial stability, providing a comprehensive view of its financial position.

Also read: What is a unit in a mutual fund

Conclusion

Assets and liabilities are important for the financial stability of the company. The rules that apply to business may not be completely suitable for you as an individual. Seeking professional advice before making investments and taking loans is very important as it plays a crucial role in balancing your assets and liabilities.

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