Assets versus Liabilities

Darryl Bachmeier
Sep 22, 2020
Finance


Assets and liability are considered the two main components of a business. It is also important in an individual’s personal life. Banks always ask for a statement of current assets and liabilities from their clients before providing them a loan. Why is this necessary? That’s because the bank needs a clear idea of your current financial position and check if you are capable enough for paying back the loan with interest in the foreseeable future. So it is of utmost necessity for an individual and also a company to have a clear understanding of what assets and liabilities mean. If you cannot differentiate between the two, then don’t worry. We will explain to you in detail what these are. So, stick with us till the end.

What are assets?

Let’s start with assets because it is easier to understand. Assets are things that you own, both physical and abstract. As long as they can be converted into cash, they count as assets. Assets keep paying you for years till it reaches its life expectancy. You may ask, the keyboard of your computer is your asset. Then how is it paying you? Let’s explain. Suppose the life expectancy of your keyboard is 3 years. So, you bought that keyboard three years. You are using it for typing in the next three years. This is how the keyboard is paying you. With its service not with cash. Without that keyboard, you might have to go to a typewriter and pay them for their work. Assets don’t necessarily have to pay you with cash. It can be a service or other means. As long as you legally own it and it pays you, it will count as an asset.

Types of assets

Assets can be divided into four basic categories judging by their qualities and mediums. Current assets, noncurrent assets, tangible assets, and intangible assets.

Current assets

Current assets are those that can be turned into cash within a year or less. Some examples of current assets can be cash, short-term investments, inventory, accrued income, foreign currency, and prepaid expenses. Current assets are placed first in the balance sheet.

Non-current asset

The only crucial difference between current assets and non-current asset is that non-current assets require more than a year to convert themselves into cash. The property, plants, factory, intangible assets, financial tax assets, investments in joint ventures, are some examples of non-current assets.

Tangible asset

Tangible assets have a physical existence. For example, land, mills, buildings, equipment, and cash.

Intangible asset

Intangible assets don’t have any physical existence. Trademark, patent, copyright, etc. are intangible assets.

What are liabilities?

Liabilities are like debts or obligations. Companies and individuals are legally bound to pay their liabilities. Note that liabilities are not costs/ expenses. Some may easily confuse these two with each other. If you borrow money, that is a liability. If you have received a service/ product and have to pay for it later, that is a liability. Costs are the money you have paid in exchange for a service/ product when receiving it. We hope that you have understood the difference between cost and liabilities. Now let’s look at the type of liabilities.

Types of liabilities

Liabilities are intangible items. They don’t have any physical existence. There are two types of liabilities. Short-term and long-term.

Short-term liability

Short-term liabilities are those that can be paid off by a year or less. They are also labeled as a current liability. They include sales tax payable, current income tax payable, provision, trade payables, and short-term financial debts.

Long-term liability

Long-term liabilities are those liabilities that need more than a year to be fully paid off. They include employee benefits liability, provision, and long-term financial debts.

Difference between assets and liabilities

Now that we know the definitions of assets and liabilities and what they mean, let’s look at some crucial differences between them.

  • First of all, assets are something that pays the business/ individual who possesses it. So, the holder gets benefited from their assets either financially or in another way. On the other hand, liabilities need to be paid off by its holder, the total opposite of assets.
  • Assets, if tangible, depreciate over time until they reach their life expectancy. That means physical assets get damaged from using and after reaching its life expectancy, it loses its value. The only physical asset that does not lose physical value is land. but liabilities do not depreciate. They stay just like the way you left them. You need to pay the full amount of your liability.
  • The goal of gaining assets is to expand the business. Liabilities are used for gaining more money with the borrowed money. With the borrowed money from liability, you expand your assets and use the money generated from assets to pay back the liability.
  • Assets bring cash to the business. They generate cash inflow. Liabilities do the opposite. They generate cash outflow for a business.
  • One of the easy differences between them is found in the accounting balance sheet. Assets are debited when they increase. But liabilities are credited when they increase.

Conclusion

These were the basic differences between assets and liabilities. There are more differences but they are for advanced level students and workers. The mentioned differences should be enough for you to identify your assets and liabilities. With that knowledge, you can easily make your financial statement and apply for a loan.

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