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Assets and liabilities are the most common accounting terms determining a business’s value. Every company, private or public, must maintain records of all the business transactions and create a balance sheet that details how many assets and liabilities a business has while operating.
The difference between assets and liabilities is the equity of the business. Every tangible or intangible receivable with monetary value is an asset, and every payable for the company is a liability. For example, when a company sells a product, they categorise the amount received as an asset in the balance sheet. In contrast, the company will add a payment made to a supplier to the liabilities section.
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What Are Assets And Liabilities?
Every receivable for a business is an asset, whereas every payable or expense is a liability. Understanding the meaning of assets and liabilities is essential if you want to run or invest in a business based on the valuation.
Assets are of two types.
1. Fixed assets are long-term assets a business owns and uses to generate income over an extended period.
2. Current assets are short-term assets a company uses to fund its day-to-day operations.
Similarly, liabilities are also of two types.
1. Current liabilities are debts a business must pay within one year or less. These include accounts payable, short-term loans, taxes owed, and accrued expenses.
2. Long-term liabilities are debts a business must pay over a more extended period, usually longer than one year. Long-term liabilities include mortgages, long-term loans, bonds, and pension obligations.
Where Can Assets And Liabilities Be Found?
Let’s take a closer look at the two using a sample balance sheet to understand the assets and liabilities meaning.
(Insert a sample image of a balance sheet)
Assets
Assets are resources with economic value that a business owns or controls and are expected to provide future benefits. A company lists them on the left side of the balance sheet, a financial statement that reports its financial position at a specific time.
The formula for assets is–Total Assets = Liabilities (Accounts Payable) + Owner’s Equity.
Liabilities
Liabilities are financial obligations or debts that a company owes to others. They represent creditors' claims on the company's assets and can be either current or long-term. A company lists the liabilities on the right side of the balance sheet.
The formula for liabilities is–Total Liabilities = Assets (Accounts Receivable) - Owner’s Equity.
Different Types Of Assets And Liabilities
Assets and liabilities difference results in valuing a company and understanding whether it is an ideal investment match. It explains how the business is performing in terms of profit and loss. Listed below are the different types, along with assets and liabilities examples.
Types Of Assets
Most assets are classified based on three broad categories.
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Convertibility
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Divided into fixed assets and current assets.
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Physical Existence
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Divided into tangible assets and intangible assets.
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Purpose
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Divided into operating and non-operating assets.
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1. Current Assets or Short-term Assets: They are assets that a business expects to convert into cash or use up within one year or less. These are usually listed on the balance sheet in order of liquidity, meaning the ease with which a company can convert them into cash. Some examples are cash, accounts receivable, inventory, marketable securities, etc.
2. Fixed Assets or Long-term Assets: These are long-term assets that a business owns or uses to generate revenue without intent for sale. Companies typically hold these for a significant period and are difficult to convert into cash in the short term. Some examples are property, plant, machinery, long-term investments, etc.
3. Tangible Assets: These assets have a measurable value and can be seen, touched, and quantified. They represent physical resources that a business can use to generate revenue. Some examples of tangible assets include real estate, vehicles, equipment, inventory, and cash.
4. Intangible Assets: These assets do not have a physical form but a monetary value. These cannot be touched or seen but represent intellectual property, brand recognition, and goodwill. Some examples of intangible assets include patents, trademarks, copyrights, trade secrets, and customer lists.
5. Operating Assets: A business uses these assets to conduct its day-to-day operations and generate revenue. Operating assets include tangible and intangible assets. Some examples of operating assets are inventory, plant, machinery, intellectual property, goodwill, etc.
6. Non-operating assets: A business owns these assets but does not use them for day-to-day operations. However, they help generate significant revenue over time. These are typically held for investment purposes or as a one-time transaction. Some examples are real-estate, patents, trademarks, and marketable investments.
Different Types of Liabilities
Here is a table containing the different liability types in the assets and liabilities statement.
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Internal Liability
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Includes liabilities and obligations such as salaries, accumulated profits, capital, etc.
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External Liability
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Includes liabilities and obligations such as borrowings, taxes, overdrafts, etc.
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Top Differences Between Assets and Liabilities
Here is a detailed table to understand the assets and liabilities difference.
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Assets
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Liabilities
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Assets contribute positively to a company’s valuation.
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Liabilities contribute negatively to a company’s valuation.
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The formula: Liabilities (Accounts Payable) + Owner’s Equity.
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The formula: Assets (Accounts Receivable) - Owner’s Equity.
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Assets generate cash inflow in the business.
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Liabilities generate cash outflow in the business.
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Financial Ratios: The Relationship Between Assets and Liabilities
Financial ratios are quantitative measures individuals can use to analyse a company's financial performance and health. They compare different financial metrics and provide insights into the company's operations, such as profitability, liquidity, and solvency. Individuals can also use these financial ratios to analyse the assets and liabilities list and understand a company’s valuation. Here is the list of financial ratios with their formula.
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Financial Ratios
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Description
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Formula
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Cash Ratio
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A company's ability to pay off current short-term liabilities using cash and cash equivalent.
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Cash Ratio: Cash and cash equivalent / Current liabilities.
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Acid Test Ratio
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A company’s ability to cover short-term liabilities using quick assets.
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Acid Test Ratio: Current assets - Inventories / Current liabilities.
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Current Ratio
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A company’s ability to pay off debt.
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Current Ratio: Current assets / Current liabilities.
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Owner’s Equity
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Presents the difference between a company’s assets and liabilities.
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Owner’s Equity: Total assets - Total liabilities.
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Debt Ratio
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Calculates the total assets of a company funded by the company debt.
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Debt Ratio: Total liabilities / Total assets.
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Financial ratios are important tools for investors, analysts, and management to evaluate a company's financial performance and make informed decisions about investment, lending, and other financial activities. By analysing financial ratios over time and comparing them to industry benchmarks, businesses can identify areas for improvement and make strategic decisions to improve their financial health and performance.
Conclusion
A list of assets and liabilities is critical for a business to showcase its financial health to investors. The relationship between assets and liabilities is vital because it helps determine a company's net worth or equity. The better a company’s assets are over its liabilities, the more customers and investors it can attract to increase revenue.
