In general, assets are anything you own that has a value. Financial assets specifically are any assets that derive their value from a contract or other claim. Although there can be a physical form of financial assets, most financial assets are not physical.
Outside of your house (if you own it), most of your personal net worth is likely in financial assets. Let’s go over what they are and how they work.
Definition and Examples of Financial Assets
Financial assets are liquid assets such as stock equity or bank deposits that assume their value from a contractual claim or ownership on an underlying asset. An underlying asset can be anything from a commodity to a piece of real estate. These real, often tangible assets are attached to financial assets, such as commodity futures or real estate investment trusts (REITs), respectively.
The most common type of personal financial assets are bank deposits and investment portfolios. In the U.S., according to recent data, the majority of personal financial assets are held specifically in checking accounts, with the second most-used financial asset being retirement accounts.
Financial assets are considered liquid because they generally can be sold easily but can also lose value over time. If a company or individual has high liquidity, that means they have enough assets to meet financial obligations.
Businesses have financial assets as well, including those in the form of accounts receivable and notes receivable. This information is listed on a company’s balance sheet. To get a better understanding of what is classified as a financial asset, let’s take a look at Home Depot’s balance sheet as of May 2, 2021, per the U.S. Securities and Exchange Commission (SEC).
In this case, the two main financial assets are cash and cash equivalents as well as receivables. Cash is all of The Home Depot’s deposits, down to the store level, while cash equivalents are short-term investments that can be converted to cash in under three months, like a money market account. Receivables is any money customers and borrowers owe to The Home Depot.
The above-mentioned assets are financial assets because the value is derived from the lease contract.
Your personal balance sheet probably looks similar to The Home Depot’s, just less complicated. Cash and cash equivalents are your checking and savings accounts as well as any brokerage or retirement accounts. Receivables is any money you’ve loaned out to people.
How Financial Assets Work
As mentioned, financial assets are any assets that derive value from a contract or other claim. More specifically, according to the International Financial Reporting Standards (IFRS), a financial asset is any asset that is:
- An equity instrument of an entity
- A contractual right to receive cash or assets—known as accounts receivable—or exchange financial assets or liabilities with another entity
- A contract that can be settled in the entity’s own equity instruments
To fully understand how financial assets work, it’s best to explain the types of financial assets in detail, as each one functions differently.
Types of Financial Assets
Below is a breakdown of the most common types of financial assets, specifically for investors.
Cash and Cash Equivalents
Cash and cash equivalents include any savings deposits, certificates of deposit (CDs), money market deposit accounts, and money market funds. These assets are considered safe, strong investments by the federal government. A CD, for example, is a type of savings account offered by banks and credit unions that typically earns interest at a fixed rate.
For deposit accounts, you sign an agreement with the financial institution and get monthly statements stating the value in the account. Accounts are generally insured up to $250,000 by the FDIC, and the type of deposit account is determined by how often funds can be withdrawn. For example, checking or demand deposit accounts can be used whenever you want, while CDs lock up your cash for a preset period.
Generally, accounts receivable are short-term business assets where a customer signs a contract, guaranteeing they will pay for the service or product in less than a year. Unlike the other financial assets, the value of receivables is based on what is owed and the probability of payment. This type of asset is used in the balance sheets of many businesses as well as universities, including Cornell University.
Stocks are often considered the riskiest financial assets, but they also offer the greatest potential for growth. Stocks represent ownership in a publicly traded company, which means when you buy a company’s stock, you become part owner of that business.
Bonds are a type of fixed-income investment in which the bond issuer borrows money from an investor. They function similarly to loans in that the borrowing organization promises to pay the bond back at an agreed-upon date. They enable companies to finance short-term projects and tend to offer modest returns.
Financial Assets vs. Real Assets vs. Intangible Assets
The other two types of assets you’ll find on a personal or business balance sheet are called real assets and intangible assets. Real assets are assets that are tangible, or physically existing, such as real estate, commodities, or equipment. Intangible assets are things like patents, trademarks, or goodwill that do not have a physical substance or financial nature.
When it comes to tax season, the IRS requires real and financial assets to be reported together as tangible assets.
As mentioned, financial assets are generally the most liquid of the three. For example, bank deposits and stocks can be converted to cash within a week in most cases, while real estate and equipment has to be listed before it can be sold.
The other thing that generally differentiates financial assets is how their value is derived. Real assets have some level of intrinsic value based on their nature as a physical asset. Intangible assets are generally recorded at cost. Financial asset values, then, can vary based on supply and demand in the marketplace where they trade.
- Financial assets are liquid assets that derive their value from a contract or agreement.
- Financial assets are different from real assets because of their non-physical nature.
- The most common personal financial assets are checking accounts and retirement investments, as well as stocks and bonds for the average investor.