Every financial tool requires information from the balance sheet to carry out its economic analysis. The balance sheet comprises assets along with equity and liabilities.
Therefore, assets and liabilities are crucial aspects of every business.
One can easily understand a business’s financial status by looking at the health of assets and liabilities on a balance sheet.
These metrics have been used repeatedly to gauge the actual performance of a business.
Let us dive into the details of assets and liabilities better to understand balance sheets and other financial analysis tools.
An asset is an owned resource with a quantifiable financial value, and it can be owned by an individual, organisation, or country, or one can also possess it through a partnership.
The primary purpose of owning an asset is to reap benefits that aid revenue formation or future earnings. According to accounting fundamentals, assets are displayed on the right side or bottom of a balance sheet, depending on the balance sheet format.
The primary purpose of an asset is also to facilitate revenue formation in a firm or increase future earnings. If a commodity increases sales or decreases expenses, it can be regarded as an asset. Assets are primarily known for generating cash flow.
There are three main attributes of an asset, and they are:
Liquidity means that an asset can be turned into cash or cash equivalents. Different assets have different liquidity periods, but they all possess an economic value, irrespective of the liquidity.
Every asset has a specific cost or price, and this price means that an asset can be exchanged for another asset or sold to settle a liability or generate cash.
The primary use of an asset is to generate financial benefits for a person or firm in the future.
The categorisation of assets is based on three factors:
Commonly, assets are categorised by their liquidity. Liquidity indicates the conversion capability of an asset to cash and cash equivalents.
Assets that can be converted easily into cash or cash equivalents have a high conversion capability. Such assets are called current assets.
Similarly, assets with low conversion capability are called fixed assets, and these assets cannot be easily converted into cash or cash equivalents.
The categorisation of assets based on physical existence has two varieties.
Tangible assets are assets with a solid physical existence that can be felt through touch.
Assets that do not exist in a solid form but still have a monetary value are known as intangible assets.
Assets are also categorised according to their usage.
Assets that carry out the core operations in a business are called Operating Assets.
But, assets that do not take an active part in business operations are called non-operating assets.
Categorising an asset is very vital in a business environment.
For instance, knowing which asset is a current asset and which one is a fixed asset plays a valuable role in evaluating a company’s capital.
In an extreme case, where the company is in a high-end risk industry, knowing which assets are tangible and not tangible helps assess its risk and solvency.
Knowing the operating and non-operating assets helps claim the revenue contribution from each asset. It also facilitates the evaluation that states, what percentage of the company’s revenue it earns from its core activities.
If liquidity is the basis of asset categorisation, then assets are classified into two types – current or fixed assets.
From the other point of view, the classification also has types called short-term assets or long-term assets.
Current assets have high liquidity, i.e. one can convert these assets into cash and cash equivalents with ease.
Hence, these assets are also synonymous with liquid assets.
Listed below are a few examples of such assets:
Non-current assets are the exact opposite of current assets, and they possess stern liquidity capabilities, so it is no child’s play to convert them into cash and cash equivalent.
Hence, they are also synonymous with long-term assets.
Listed below are a few examples of such assets:
Assets can also be categorised based on their physical availability into tangible or non-tangible assets.
Tangible assets are assets that we can see, touch and feel.
A few examples of such assets are:
Intangible assets are assets that lack physical existence.
A few examples of such assets include:
If usage and motive are the basis of asset categorisation, those assets have two varieties – operating and non-operating assets.
The operational activity of a business environment requires certain assets to function with ease. Those assets are known as operating assets, and they are primarily used to extract revenue from a company’s core activity.
A few examples of such assets include:
These are the assets which are not required in day to day activities but are still capable of extracting revenue.
A few examples of such assets include:
Flourishing companies have assets in all nooks and crannies of their business. Here are some insightful and variegated examples that will help you identify assets in a business.
If any commodity promises financial benefits to a person or business in the current or future, it can be termed an asset.
The asset can be any entity whose ownership is in your possession, and it can be anything from a factory estate to a bond of service delivery.
If you own a motorcycle, a real estate property, or a study table, these are your assets. Similarly, if you have given a loan of 50,000 rupees to someone, that loan is also an asset for you. But, this loan is a liability for the one who has taken it from you.
Labour is the work done by employees of a company. Hence, labour is not an asset because an employee is free from the company.
Employees have the power to make their own decisions. So, if an employee wants to leave, they can take their skillset and aptitude with them. Therefore, one should not consider employees as an asset.
But, under accounting principles, the work done by the employee is considered an expense known as salary or wages.
But, we incur salary or wages while manufacturing or delivering a product or service. This product or service, however, is an asset.
The categorisation of assets is done differently in the accounting books than in the ones mentioned above.
The assets are categorised with this intensity while recording assets in the accounting books. The segregation is primarily based on liquidity - fixed assets and current assets.
Further, accounting techniques for intangible assets can be a little tricky. It is challenging to decide the value of an intangible asset, and there is no conventional method to measure intangible assets.
When someone fails to accurately specify the value of an intangible asset, the company fails to report it on the balance sheet.
In a balance sheet, the accounting treatment of tangible assets is different from that of intangible assets.
The expenses incurred on a tangible asset are known as depreciation, and the intangible assets have their expenses mentioned as amortisation.
Depreciation and amortisation are vital for the correct valuation of a business. They also significantly impact the business income like operating and non-operating income.
Hence, it is essential to ensure that the different types of assets are treated accordingly.
Liabilities - meaning
Liability means that a person or company is liable to provide some economic benefits to another person or company.
A liability is an obligation, and in financial terminology, it states that a person or a company owes either money or services to someone.
The settlement of liabilities happens by transferring the pre-decided money or service to the required entity.
According to accounting fundamentals, liabilities are displayed on the left side or top of a balance sheet, depending on the balance sheet format.
People or companies use liabilities to fund and expand their businesses instead of facing financial restrictions that hamper business growth.
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