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What are Assets and Liabilities?

10 Mins 22 May 2023 0 COMMENT

Assets and liabilities are fundamental concepts in accounting and finance. They are both vital components that determine the financial stability of an individual or a company. In layman’s language, assets are anything a firm owns and has value, while liabilities are something the company owes to others.

A company’s profitability depends on how well it manages its assets and liabilities. Understanding what are assets and liabilities is essential for anyone who wants to manage their personal or business finances effectively.

Assets are resources that have economic value. They are owned by an individual or a company. For a company, assets can be physical, such as plant and machinery, property, or inventory, or they can be intangible, like trademarks, goodwill or patents. Assets are used to generate income or to create value for their owner.

On the other hand, Liabilities are the financial obligations that an individual or a company owes to others. Liabilities can include loans, accounts payable, debts and taxes owed. They help in financing a company’s expansion and daily operations.

Understanding a company’s assets and liabilities is essential for investors, creditors, and other stakeholders in evaluating a company’s financial health and performance. Let us look at the types of assets and liabilities, the difference between them and where they can be found.

Where Can Assets And Liabilities Be Found?

Assets and liabilities are the two critical components of a company’s balance sheet and determine the financial health of the business. A balance sheet is a financial statement that shows all the assets, liabilities and equity of a company. It is a snapshot of a company’s financial position at a specific point in time.

Assets can be found typically listed on the left side of the balance sheet. The liabilities are seen on the right-hand side of the balance sheet along with shareholder’s equity. The difference between the total assets and total liabilities of a company is its equity or net worth. The equity capital represents the value of the company’s assets that are owned by shareholders. All the assets of a company must always equal its liabilities plus equity on the balance sheet.

Different Types of Assets and Liabilities

There are numerous types of assets and liabilities, which can be categorised based on their characteristics and dimensions.

Types of Assets

Current Assets:  Current assets are those that can be easily converted into cash or its equivalent within a year. They are liquid assets such as cash, inventory, and short-term investments. These resources are crucial for everyday operations because they offer the liquidity required to satisfy immediate obligations.

Fixed Assets: These are the assets that cannot be converted easily into cash, such as real estate, land, machinery, equipment, patents, goodwill, etc., and are estimated to bring the business long-term advantages. Fixed assets are usually purchased for productive use, and their value is depreciated over time.

Tangible Assets: These assets are those that have a physical existence, like inventory, machinery, building, marketable securities, etc. Tangible assets can be used for productive purposes and provide long-term benefits to the company.

Intangible Assets: These assets do not have physical existence and comprise patents, trademarks, and copyrights. Intangible assets are essential for brand recognition, competitive advantage, and generating revenue.

Financial Assets: Financial assets are funds which include stocks, bonds, and options. Financial assets provide investors with opportunities for returns, capital gains, and diversification.

Types of Liabilities

Current Liabilities: A company’s short-term financial commitments that are due in a year or within a typical operational cycle are known as current liabilities. These liabilities are intended to be settled in a year or less.

Long-Term Liabilities: Long-term liabilities are often known as long-term debts. They are sums owed by a company to third parties and are due after 12 months.

Contingent Liabilities: These are potential liabilities that may arise from past or current events. For instance, lawsuits, warranties, and guarantees.

Operating Liabilities: These are responsibilities, such as those for salaries and wages, rent, and utilities, resulting from the company’s regular activities. Operating liabilities represent the company’s ongoing obligations to pay for its daily operations.

Financial Ratios from Assets and Liabilities

The relationship between assets and liabilities is a key element in understanding a company’s financial health. The company’s profitability depends on the effective management of its assets and liabilities. There are certain financial ratios that provide a way to measure this relationship and analyze the company’s financial position.

Here are some commonly used financial ratios that provide insight into the relationship between assets and liabilities:

 

Financial Ratio

Description

Formula

Debt-to-Equity Ratio

It measures the total amount of debt a company has in relation to its equity.

Total Debt / Total Equity

Current Ratio

It measures the company’s ability to pay its current liabilities using its current assets.

Current Assets / Current Liabilities

Quick Ratio

It measures a company’s ability to pay its current liabilities using its most liquid assets.

(Current Assets - Inventory) / Current Liabilities

Debt Ratio

It identifies the proportion of a company’s assets that are funded by debt.

Total Debt / Total Assets

Owner Equity Ratio

Measures the percentage of a company's assets that are financed by owner's equity.

Owner's Equity / Total Assets

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