BAJAJ BROKING
September 17, 2024
4 mins read
Assets and liabilities are two of the most commonly used terms in finance. An asset is a resource that can provide you value in the short or the long run. However, a liability is what you owe to someone. For a business, common types of assets include plant, machinery, cash, marketable securities, accounts receivables, prepaid expenses, etc. The most prominent liabilities for a business include short- and long-term loans, debentures, unpaid expenses, etc. A business raises money through liabilities to acquire assets in order to generate sufficient return for its shareholders and repay those liabilities.
Whether you are an individual or a business, it’s extremely important to understand the meaning of assets and liabilities. Assets are those things that you own and that can provide you value. However, liabilities are funds raised by you from other parties. Hence, you owe them to the extent that you have raised funds from them. Read this blog, as it explains in detail what assets and liabilities are, the types of assets and liabilities, and a lot more relevant to this topic.
An asset is something that has some value for its owner. The owner could be an individual, a business, the government, or anyone else. An asset can provide value today or in the future, but it’s extremely important that it provides value, else it’s not an asset.
You can buy an asset from your own funds or borrowed funds. In other words, the source of funds is not important. For example, if a business buys machinery, it will be its asset, whether it has used its own funds or it has taken a loan for this purpose.
A business’s assets are resources acquired by it from all the funds it has, including shareholders’ funds and borrowed funds. Hence,
Total Assets = External Liabilities + Shareholders’ Funds
When you owe something to someone else, it’s known as liabilities. The borrower can be an individual, a business, the government, or anyone else. When an owner invests money in his business, that money is a liability for the business because the business has to pay that money back to its owner.
The most common types of liabilities for a business include short-term and long-term loans. Similarly, when an individual takes a loan to build a house, buy a car, or for any other purpose, it’s that person’s liability.
External liabilities are funds borrowed by a business from other parties. Here’s the formula for it:
External Liabilities = All External Long-term Liabilities + All External Short-term Liabilities
The various types of assets are described below:
Current Assets – The assets that can be converted into cash within a year are called current assets, for example, inventory or stock of goods, debtors, prepaid expenses, and of course cash and cash equivalents.
Fixed Assets – The assets that are purchased to be utilised over a long-term are called fixed assets, for example, plant and machinery, equipment, etc.
Financial Assets – When we invest in shares, bonds, or any other financial instrument, these are known as financial assets.
Intangible Assets – The assets that can’t be seen or have no physical form are known as intangible assets, like goodwill, copyrights, trademarks, and patents.
The prominent types of liabilities are explained as follows:
Current Liabilities – The liabilities that are payable in cash within a year are known as current liabilities, for example, unpaid wages and salaries of staff, interest payable on loans, dividends payable on shares, short-term loans due within a year, etc.
Long-Term Liabilities – The liabilities that are due after a year are known as long-term liabilities, for example, long-term loans and debentures of a business.
Shareholders’ funds – Now, this is an interesting one. When a shareholder invests funds in a business, it’s not his liability. However, it is the liability of that business because it owes those funds to the shareholder.
The main differences between assets and liabilities and their types are summarised below:
Assets | Liabilities |
Assets are resources owned by an individual, a business, the government, or anyone else. | Liabilities are what you, a business, the government, or someone else owe to another party. |
Assets provide value either currently or in the future. | Liabilities have to be paid either in the current year or in the future. |
Assets are purchased either from a business’s own funds or liabilities. | Liabilities are funds raised by a business or anyone else from outsiders. |
From a business’s viewpoint, assets show how well its resources are generating value. | From a business’s perspective, liabilities show how prudently a company has borrowed funds from others for its operations. |
Examples of assets include plant & machinery, trademarks, patents, accounts receivables, prepaid expenses, cash and cash equivalents, and marketable securities. | Examples of liabilities include short-term and long-term loans, debentures, bonds, unpaid expenses, etc. |
A business’s assets affect its financial health based on how it utilises them. For example, if a firm has a plant, which is not able to manufacture high-quality products, then the firm will find it tough to make money. Conversely, if its plant is able to make high-quality products, it will be able to do good business.
A business’s liabilities affect its financial health based on how it raises them. For example, if a firm raises a debt at an extremely high interest rate, it will be detrimental to its profits. It can even result in a situation, wherein the firm may not be able to pay its loan, which will badly affect its reputation.
All of us in our personal capacity have some assets and liabilities. For example, a lot of people own a house, a mobile phone, a car, a bike, some furniture, etc. These are their personal assets. Their owner owns such assets in their personal capacity.
Similarly, a lot of us have liabilities in our personal capacity as well. Examples of liabilities taken in a personal capacity include housing loans, credit cards, car loans, education loans, etc.
From a business’s viewpoint, its assets include current assets (debtors, inventory, prepaid expenses, cash and cash equivalents, etc.), fixed assets (plant & machinery), financial assets (investments in stocks and bonds of other companies), intangible assets (patents, goodwill, trademarks, etc.)
A business’s liabilities include current liabilities (unpaid wages and salaries, short-term loans, creditors, deferred tax liabilities, etc.), and long-term liabilities (loans that are payable after a year).
A business’s liabilities also include the funds invested by its shareholders. It’s a business’s responsibility to generate a sufficient return on its shareholders' funds. Besides, when a business is liquidated, it has to return the money invested in it by its shareholders. That’s why shareholders' funds are shown on the liabilities side of a company’s balance sheet.
If you are opening a demat account (free or otherwise), it’s not tough to understand the meaning and types of assets and liabilities. However, it can be challenging to utilise an asset well. Likewise, it may be tough to pay a liability in due time. Hence, a good business is one that utilises its assets to generate sufficient returns for its shareholders and pay all its external liabilities in due time. If it’s not able to do so, then it’s not a well-managed business.
Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.
This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
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Assets are resources owned by a company, an individual, or the government that provide value. Liabilities are funds borrowed by a company, an individual, or the government from someone else.
Current assets can be liquidated to generate cash in short-term (within a year), for example, debtors, inventory, cash and cash equivalents. Noncurrent assets can be liquidated to generate cash in the long-term (after a year), like plant and machinery, goodwill, trademarks, etc.
A company’s assets are always equal to the summation of its external liabilities and shareholders’ funds. If they are not equal, then there’s definitely an issue, which needs to be sorted.
The types of liabilities include short-term liabilities which are due within a year (like creditors, unpaid expenses and taxes, short-term loans, etc.) and long-term liabilities which are due after a year (like long-term loans, debentures, etc.).
Assets and liabilities of a business are closely interlinked. A business raises funds through liabilities to invest in assets so that it can generate sufficient returns for its shareholders and repay those liabilities.
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