Guide to Assets and Liabilities
Assets are anything of value that your business owns and liabilities are its debts and obligations. Understanding assets and liabilities is a critical component of small business accounting because they represent the company's financial health.
Assets and liabilities are reported on the company's balance sheet. The balance sheet is a financial statement that summarizes what a business owns and owes and the amount of equity owned or invested by the owner.
Take the guesswork out of knowing the real numbers for your company's assets and liabilities by generating a balance sheet using Skynova's accounting software. Follow along as we review what assets and liabilities are and how they appear on a balance sheet.
What Are Assets?
Assets refer to any resources that your business owns. You buy or produce assets for the purpose of generating income for your company. The balance sheet shows your company's total assets and how they're financed, whether through debt or equity.
On the balance sheet, asset accounts are listed in order of their liquidity — how easily they can be converted into cash. The asset section is divided into current assets and non-current or long-term assets. Current assets consist of resources that can be converted to cash within one year or less, while non-current assets include long-term investments, fixed assets, and intangible assets.
Read more on the different types of assets below.
Understanding the Different Types of Assets
Here's a look at the different types of assets and explanations of each.
Types of assets, according to liquidity:
- Current assets or short-term assets: These are assets that can be readily sold and converted into cash within one year of the company's operating cycle. This is why they're also called liquid assets.
- Long-term assets: These are assets held or owned by a company for more than a year that are expected to benefit a company for many years. Long-term assets include fixed assets and intangible assets.
- Fixed assets: These are assets owned by a business that have a useful life of more than one year, with values that are reduced through depreciation annually. Fixed assets are generally used in the day-to-day operations of a company.
- Tangible assets: These are physical assets or properties owned by a company. A business's fixed assets, such as equipment, land, and buildings, are considered tangible assets.
- Intangible assets: These are non-physical assets that present an economic or monetary value for the company. Examples of intangible assets are intellectual properties like patents and copyrights.
- Operating assets: These are assets used in the daily operation of a business to generate income. Examples of operating assets include cash, raw materials or inventory, and machinery.
- Non-operating assets: These are assets held by a business that generate revenue or may provide future income but are not used for day-to-day operations. Examples include short-term investments, money market securities, and real estate.
Types of assets, according to physical existence:
Types of assets, according to purpose:
According to the Financial Accounting Standards Board (FASB), "Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events." Hence, an item or an investment is considered an asset if you own it, it has economic value, and it can be sold or used to earn future economic benefits.
Some examples of business assets include:
- Cash and cash equivalents (physical cash or payments made through debit or a business bank account)
- Accounts receivable
- Office furniture and equipment
- Stocks, bonds, and securities
- Accounts payable (money owed to suppliers)
- Rent and utilities payable
- Salaries and wages
- Income tax payable
- Line of credit or short-term loans
- Interest payable for short-term or long-term debts
What Are Liabilities?
Liabilities are debts and obligations that a business owes to outside parties. Examples include office rent, salaries and wages, invoices from suppliers, and bills from utility companies. The two types of liabilities are current and long-term liabilities.
Current liabilities include payables due now and within one year. Company expenses, such as salaries, supplies, and rent, fall under the current liabilities category. Long-term liabilities are debts that have due dates beyond one year (e.g., mortgages and vehicle loans or leases).
Understanding the Different Types of Liabilities
Liabilities are primarily categorized according to their due dates. That's why there are current or short-term liabilities and non-current or long-term liabilities. There's also a special categorization called contingent liabilities.
- Current liabilities: These are due within a year and include most of the company's expense accounts needed for day-to-day operations and tax liabilities.
- Non-current liabilities: These are due after more than one year. These include debts from a company's financing activity, such as issuing notes payable and taking on a mortgage or a long-term lease to raise capital.
- Contingent liabilities: These may or may not happen, depending on the result of a future event. Companies report contingent liabilities when the outcome is most likely to happen and if the resulting liability can be reasonably estimated. An example of this scenario is when a company reports contingent liability for legal expenses.
Here are some common debts and obligations that a small business incurs:
What's the Difference Between Assets and Liabilities?
An asset increases the value of your company, but any debt or obligation you have reduces it. Liabilities are part and parcel of running a business. It's not avoidable unless you only deal with cash (though that would not be ideal either because your suppliers and customers may not operate that way).
The trick is for your business not to take on too much debt and to make sure you always have enough working capital to cover operating expenses and loans that may come due.
What Do Assets and Liabilities Look Like on a Balance Sheet?
A balance sheet is a financial document that shows a company's assets, liabilities, and owners' equity in a given period of time. It's one of the three essential financial statements, along with the income statement and statement of cash flows, used to assess a company's financial position.
The balance sheet tells us how much of a company's assets are funded by equity or debt. A thriving business has more assets than liabilities. If a company owes more than it owns, its net worth is negative. To keep the business going, the owner may need to invest more money and then look for the reason the company has so much debt.
The balance sheet is based on the fundamental accounting equation: Assets = Liabilities + Equity. Liabilities and equity are presented on the right side of the balance sheet, and assets are shown on the left.
Example of a balance sheet:
Wendy's Wedding Photography
Dec. 31, 2020
|$4,500 in cash||$5,000 in loans (borrowed from a credit card to buy a camera)|
|$10,000 in equipment (camera and lens)||$22,500 in car loan (borrowed from the bank to buy a vehicle)|
|$7,500 in equipment (laptop, tripod, and props)||Equity|
|$22,500 in vehicle||$17,000 (owner's investment)|
Total Liabilities and Equity
Let Skynova Help You Manage Your Small Business Bookkeeping
As a small business owner, you must have a firm grasp of what constitutes assets and liabilities. This will help you understand how to balance your books and assess the financial health of your business.
Test your new knowledge by generating a balance sheet or a cash flow statement with Skynova's accounting software. Seeing where your business stands helps you make better-informed decisions in running and growing your business.
Notice to the Reader
The content within this article is meant to be used as general guidelines and may not apply to your specific situation. Always consult with a professional for specific and individual accounting advice.