Assets and liabilities are important components of each business. People doing any type of business should understand the concept of assets and liabilities, as they are often used to ascertain the financial condition of any business. So through this article, we are going to do comparative analysis of these two and convince you how important they are for business.
Before you talk about assets, try to understand its concept and know what it means on the balance sheet of a company. Assets are resources that help any business benefit. These resources are owned by the company and are controlled by the company. The resources of a company are called its assets only when they have the following characteristics –
- To provide economic benefits in future.
- Be something that the company has control over.
Types of assets
Assets can be divided into two categories, which are –
- Current Assets (Current Assets) – Assets that can possibly be converted into cash within 1 year are called current assets. Current assets include cash and cash equivalents, inventories, short-term investments, liquid assets, etc.
- Fixed Assets (Fixed Assets) – Fixed assets are resources that are held for more than a year. The business to which these assets are attached has a financial value. For example, machinery or transportation used in a business may be considered immovable property. Companies depend on their current asset reserves to pay their obligations. On the other hand, real estate is the liabilities of a company, which lasts for many years. These cannot be quickly converted into cash.
Liabilities are the obligations of any business that has to fulfill that business. The most common business liabilities are accounts payable, ie the company makes payments to suppliers. Every business has liabilities.
Types of liabilities
Liabilities can be classified into two types, which are –
- Current liabilities – The liabilities that have to be repaid within a year are called current liabilities. These include salary, accounts payable, loans and lines of credit.
- Long term liabilities – Financial obligations of any business which have to be repaid after more than one year are called long-term liabilities. Such loans are often used to understand the capital structure of a company.
Assets vs. Liabilities
We have discussed earlier that assets and liabilities are two important components of a company’s balance sheet. Let us now understand some important differences between the two –
- Assets provide benefits to any business. It helps the manufacturing process, provides services and has a value in the future, but liabilities are the company’s obligations. Liabilities can be in the form of financial obligations or services.
- Both assets and liabilities are important components of a company’s balance sheet. However, a third component is also mentioned in the company’s balance sheet, known as shareholders’ equity. The balance sheet has assets on the left, while liabilities on the right. Shareholder equity is used to balance the equation. Thus the remaining assets represent the company’s shareholder claim after subtracting the total assets from the total liabilities.
- The company should have more assets than liabilities. Having more assets means that the company has sufficient liquidity to pay its dues. If a company has more liabilities than assets, it means that it will not be able to pay its obligations and may have to face financial crisis.
- If a company has liabilities to the best of its ability, it helps to grow its business and having liabilities is not always bad. Sometimes it is necessary. For example, if a company increases its liabilities or takes loans to purchase machinery or equipment, these tools help the company expand and operate. This is a positive thing for any business. However any business should avoid liabilities and prevent them from growing rapidly.
Understand assets and liabilities through examples
A person operating a small business must understand the concept of assets and liabilities to get an idea of their company’s financial position. It is explained through an example of a painting business below –
- Business Assets – Painting equipment, bank account savings, office furniture and equipment (computers and printers), vehicles and painting contracts etc.
- Liabilities – Salary of employees, paintings purchased on credit, business loans taken for purchasing office, tax on income, insurance and benefits payable to employees etc.