Assets and liabilities are terms frequently used in business to state the property owned and the debts incurred, respectively. Assets are the properties or items owned by a business, and they increase the business’s value. Liabilities are the amounts owed by the business—in other words, debts that decrease the business’s value. Assets and liabilities are listed together on a financial statement known as the balance sheet.
A balance sheet is a financial tool used in business to determine a company’s assets and liabilities within a particular time period. Assets are listed on the left side of the balance sheet, while the liabilities are listed on the right. Both must equal the same amount and thus “balance” each other out.
It’s important to understand how a balance sheet works to know how the money is flowing in and out of your business. Using a balance sheet can help you make decisions about your business and give you an understanding of where your business stands financially. If you’re seeking investors, this financial document can give them insight and help them to decide if your company is worth the investment.
- An asset is something owned, such as property and equipment, that brings value to a business. A liability is what the business owes and must be paid out.
- Assets must balance out to the value of liabilities and shareholder’s equity, which is listed on a financial tool known as a balance sheet.
- Assets may be tangible, such as a building or inventory, or intangible, such as intellectual property.
- Liabilities comprise all debts owed by the business to people or other businesses, such as employees, clients, and banks.
What Are Assets and Liabilities?
Assets and liabilities may appear side by side on a balance sheet, but they differ when it comes to what they actually represent. There are varying types of assets, just as there are different types of liabilities.
Assets are the properties owned by the business, which usually are used in production but may be sold at any point. Assets can be either tangible, such as equipment, supplies, and inventory, or intangible, such as intellectual property.
A tangible asset is an actual object, something that can be seen in physical form and used for the business. Examples of tangible assets include:
- Production equipment
Common office supplies, such as paper, computers, and printers, can also be in this category, although they may not be included if they get used up over time.
Intangible assets are the opposite of tangible assets, as they are not physical property but rather something that isn’t seen, such as a service or a benefit. Examples of intangible assets include:
- Trade names
- Branding aspects
- Networking contacts
- Intellectual property, such as trademarks, copyrights, patents, and websites
Intangible assets are important because they can be of high value, but they are not specifically listed on the balance sheet.
Current Assets vs. Noncurrent Assets
Assets are also categorized according to the time period during which the business expects to turn them into cash. Current assets are those that will be cashed in within the current fiscal period, which is usually one year. Noncurrent assets are long-term assets that can’t be liquidated within the current fiscal period.
For example, the inventory a company owns—but expects to sell within the current fiscal year—would be considered a current asset. If the asset, such as intellectual property or equipment used in production, can’t be converted into cash within that specific year or time period, then it is considered a noncurrent asset.
Liabilities are the debts owed by the business. They include anything the company still owes, whether it be to employees, customers, or investors. Some examples of liabilities include expenses such as loans, payroll, and accounts payable.
Liabilities are also categorized, just as assets are, according to the time period when the debts are to be paid. Current liabilities refer to debts owed by the business that should be paid within the current fiscal year. Noncurrent or long-term liabilities are not yet due within the current fiscal period.
For example, one current liability that should be paid within the fiscal period is the salary due to employees. Because employees typically receive their pay within the month in which they worked, these payroll expenses would be considered current liabilities. Examples of noncurrent liabilities include taxes or loans that are to be paid in increments and are not yet due within a current fiscal period.
When valuing your assets, you can opt for the market approach, which equals the current market value, or you can choose the cost approach, which equates to the original cost of the item.
What’s the Difference Between Assets and Liabilities?
Assets and liabilities are both listed on a balance sheet and essentially balance each other out when it comes to a company’s finances. Assets are what the company owns, but the liabilities are what the company still owes.
They are basically opposite in meaning: Liabilities refer to the outward dealings and transactions of a business, while assets refer to the incoming dealings and items of value.
The main difference between assets and liabilities is that one adds to a company’s net worth while the other deducts from it.
Assets are the things owned by a company and therefore add to the company’s value. Liabilities are what the company owes, whether to employees, customers, or banks. Liabilities can have a huge impact on a business if they exceed assets, a situation that can hinder its growth.
What Is Equity?
Equity is commonly known as shareholder’s equity or owner’s equity. When listed on a balance sheet, though, it may also be referred to as net worth or capital. A shareholder’s equity equals the number of assets minus the number of liabilities. This is essentially the profit that belongs to the owners once all debt is covered.
On the balance sheet, equity is placed on the right side with the liabilities. The commonly used formula for the balance sheet is:
Assets = Liabilities + Shareholder’s Equity
Therefore, the formula for calculating equity is simply:
Shareholder’s Equity = Assets - Liabilities
Calculating the net worth of your business is important so that you know where your business stands financially. Net worth reflects the value of a company from the investors’ perspective and can affect their decisions to invest. Knowing this also helps to improve your understanding of whether your business can afford upgrades and other improvements.
Frequently Asked Questions
How do you find net assets from liabilities?
The net assets of a business are similar to the meaning of net income. Just as net income refers to the amount after debts are paid, net assets are calculated when you subtract the total assets from the total liabilities. For example, if assets equal $70,000 and liabilities equal to $50,000, then your net assets are $20,000.
How are assets and liabilities ordered on a balance sheet?
On the balance sheet, assets are listed on the left side, while liabilities are listed on the right. A shareholder’s equity is also listed with the liabilities. This layout reflects the formula: Assets = Liabilities + Shareholder’s Equity. Assets and liabilities can be further divided on the balance sheet to show the current assets and current liabilities due in the fiscal period.
What are the differences between current assets and current liabilities?
While both current assets and current liabilities refer to transactions within the immediate fiscal period, they differ in the sense that one is incoming, while the other is outgoing. Current assets are the things expected to bring value within the current fiscal period, while current liabilities are the amounts owed in that same period.