Knowing your business inside out determines your success as a business owner. Most business owners have a basic understanding of how much their business owns and what it owes other people. In other words, they are aware of their basic assets (like their bank balance, inventory, and equipment) and liabilities (like account payables, loans, and debts).
But if you dig deeper, you may come across some things you didn’t know are assets or liabilities.
So what, exactly, are those items? Let’s explore what kinds of assets and liabilities a business can have and how to categorize them.
Assets vs. Liabilities
Everything your business owns is an asset—cash, equipment, inventory, and investments. Liabilities are what your business owes others. Have you taken a business loan or borrowed money from a friend? Those are liabilities.
Assets and liabilities determine how much your business is worth—and calculating your business’s worth can:
- Tell you how much your business has grown over the years.
- Help you make realistic financial goals.
- Figure out how much of a loan you may get.
- Estimate your business’s selling price.
- Get the insurance coverage you need for your business.
Sounds simple, right? But sometimes assets and liabilities aren’t that easy to identify.
For example, there are assets you can’t sell and others that you can. If your product is well-known in the market, you might have brand recognition as an asset. But you can’t necessarily sell that brand recognition on its own. Your inventory, on the other hand, is an asset you can sell.
Another example—liabilities might not always be money you borrowed or loans you have taken. Even an upcoming premium for your worker's comp insurance is a liability. It’s important to recognize these liabilities and try to find ways to minimize them. For example, Hourly connects workers’ comp directly with payroll–so premiums are always accurate and you’re never paying for more or less coverage than you actually need.
Examples of Assets vs. Liabilities
Are you ready to explore your company’s assets and liabilities? Let’s take a look at some examples to help you get started.
- Examples of assets: Cash, inventory, building, furniture, and accounts receivable
- Examples of liabilities: Loans, accounts payable, sales tax payable, and debts
But wait a minute, aren’t big words like assets and liabilities for big companies? Why should I waste my time chasing them?
No matter how small your business is, learning about assets and liabilities is crucial for your business's financial health. We promise not to scare you off with big definitions.
Let’s go back to the basics, shall we?
What Are Assets?
Anything your business owns that can help you generate cash in the near or far future is an asset. For example, if you put money in the stock market, you can sell those stocks to generate cash. Similarly, some assets help you run your business—for example, your tools or equipment.
Assets could also be things that increase the value of your business. If you have a patented manufacturing process, you may have a competitive advantage in the market.
So, some assets generate quick cash, and some don’t. That brings us to the concept of liquidity of an asset.
What Does Liquidity of an Asset Mean?
The liquidity of an asset measures how fast you can convert the asset into money. Assets like cash, your bank balance, and bonds are highly liquid assets. On the other hand, some assets—like your tools—won’t generate quick cash. Those are low liquidity assets.
But, liquidity is not the only way to categorize assets. If you look closer, you’ll be able to recognize a variety of other asset categories in your business.
So, what are those types of assets?
What Are the Major Types of Assets?
Assets come in every size and shape, from cash to an espresso machine. Every asset helps your business in one way or another. For example, an office building you own can act as collateral while applying for a business loan.
So, it’s crucial to have a clear idea of what assets can help you at which point. Categorizing your assets will help you better understand what you own and how to use them.
Current Assets vs. Fixed Assets
Current or short-term assets are items you can quickly or easily convert into cash. You’ll be able to get your cash within the same financial year. Current assets are also called liquid assets, as it is easy to liquidate them (i.e., sell them on the market). Current assets help you run your business without borrowing money.
Fixed assets, also known as non-current assets or long-term assets, help you run your business in the long term. For example, your equipment enables you to get work done faster, and your office space helps impress new clients.
Yes, you may sell fixed assets if you want, but it’s generally a longer process—which means you won’t be able to quickly turn that asset into cash. Think about the long process of selling a building or land. From finding a buyer to the final deed, it may take months to years.
Every fixed asset doesn’t take this long to sell. For example, you’ll be able to find a buyer for your furniture or espresso machine quickly. But you still need to negotiate the price, arrange for pickup, and get your money. In other words, converting them into cash is not as easy as selling bonds or stocks.
Word of advice: Don't rely on fixed assets to generate quick cash.
Examples of Current Assets
When you think about current assets, you might think of cash and bank balance. But here’s the good news: Your business probably owns much more current assets, such as:
- Inventory: Your inventory of products or raw materials is a current asset. You can sell them at the market rate and generate money.
- Accounts receivable: As a business, you’ll have payments due from your customers. As these payments result in cash flow into your account, they are current assets.
- Marketable securities: These are investments you can quickly convert into cash—for example, stock, mutual funds, or bonds. You may sell them at any time to generate cash.
- Prepaid expenses: If you paid for any goods or services in advance to be received in the future, it’s a current asset. It's similar to holding onto inventory since you can cancel or transfer these goods and services to get your money back. For example, if you have paid a 12-month retainer to a marketing agency, it’s considered an asset until the service is complete.
Examples of Fixed Assets
Real estate and machinery are two easily identifiable fixed assets. But your company may have many more fixed assets, such as:
- Vehicles: Any vehicle your business owns is a fixed asset. For example, the mini truck you bought to transport supplies is a fixed asset. Specialized vehicles like forklifts are also fixed assets.
- Fixtures and furniture: If you have a $1,000 couch in your lobby or an air conditioner in your office, they’re fixed assets—and so is every other piece of furniture you own.
- Office equipment: Offices usually have costly equipment like computers, printers, fax machines, and telephones. They all come under fixed assets.
Tangible Assets vs. Intangible Assets
Assets that have a physical existence or a clear market value are tangible assets. For example, cash, machines, and furniture have a physical existence. Assets like accounts payable and stocks have an objective market value. It means you can calculate their value at any point in time. These are tangible assets.
But there are other kinds of assets that exist only virtually. You won’t be able to attach a precise value to them. They’re known as intangible assets.
But, wait! If they’re intangible, how will they generate money or help me run my business?
Let’s look at some examples of intangible assets to answer your question.
Likewise, if you own a famous brand with a well-known logo and tagline, you own another intangible asset—brand recognition. Brand recognition helps your customers remember your brand when they need something.
See how intangible assets can help you succeed in your business?
How do you recognize intangible assets? Here are some examples to help you out.
Examples of Intangible Assets
- Brand value: Even if you can’t assign a monetary value to your brand’s reputation, it’s an important asset that will help you attract customers and investors.
- Intellectual property: Patents, copyrights, and trademarks are common examples.
- Business licenses: If you hold a business license that’s hard to acquire, it’s an intangible asset.
Now that we’ve looked at assets, let’s look at the other side of the coin: liabilities.
What Are Liabilities?
Liabilities represent your financial obligations to other people or businesses. Have you taken a business loan or borrowed money? Do you have upcoming tax payments or insurance premiums? Those are all examples of liabilities.
If you have liabilities, you’ll need to take money out of your business to pay them. Keeping track of liabilities is required to ensure you have sufficient funds to pay them off on time.
What Are the Major Types of Liabilities?
Depending on the type of liability, you may have to pay it back immediately or at some point in the future. Liabilities are divided into two categories based on when they’re due—short-term liabilities and long-term liabilities.
Short-Term vs. Long-Term Liabilities
If you have an upcoming insurance premium or a tax payment, it’s considered a short-term liability. You need to pay these liabilities within a short period of time, typically in the same financial year. These are also known as current liabilities.
Keep an eye on your short-term liabilities as they have the potential to disrupt your daily operations. For example, say you need to buy $1,000 worth of raw materials this week. You’d need to ensure you have $1,000 ready to pay the supplier so production doesn’t stop.
Other examples of short-term liabilities include bank overdraft fees, upcoming credit card payments, tax liabilities, accrued wages, short-term loans, and supplier payments.
Long-term liabilities are liabilities you don’t need to pay in the near future; typically, they’re due a year or more out. Deferred tax, which is a tax liability you need to pay at a future date, is an example of a long-term liability or non-current liability. Long-term bonds that mature after a year are another example of a long-term liability.
Again, long-term liabilities are typically not due for settlement within the same year. While they aren’t urgent, keeping track of your long-term liabilities will save you from unpleasant financial surprises.
Liability can also have short-term and long-term components—for example, long-term loans.
Suppose you have taken a loan of $10,000 that needs to be paid off in ten years. In that case, the loan amount is considered a long-term liability, while the next 12 month’s worth of interest and principal payments are considered short-term liabilities.
Real-Life Examples of Asset vs. Liabilities
Now that we've got the basic definitions out of our way, let’s look at a few real-life examples of assets and liabilities.
Example 1: Buying Property
Let’s say you own a painting company, and you've been operating out of your garage for the past few years. Now, you want to move into a proper office space. Assume you take out a mortgage and buy a small office.
The office space is an asset—you now have a proper business address that may attract more customers. You can also sell the office space if the need arises.
The flip side is that you’ve taken out a mortgage, and that’s a long-term liability. You’ll need to make extra money to pay off this long-term debt.
Example 2: Getting Supplies on Credit
Say you do well in your new office and land a bunch of new clients. But now there is an issue: You don’t have enough inventory to start a new project.
So, you contact your suppliers, and they agree to give you supplies on credit, which you must pay back within two months.
The inventory you receive is an asset that will help you make money from the new projects. But the amount you need to pay back to suppliers is a short-term liability.
Example 3: Leasing/Buying a Vehicle
Say your business continues its smooth sailing, and you want a car in addition to your pickup truck. You have three options:
- Lease a car for a long period of time
- Take out a vehicle loan and buy a car
- Buy a car in cash
If you take out a vehicle loan or lease, it becomes a significant liability. But after you pay off the loan, the car is yours. After a lease ends, you turn the car in so you don’t have an asset.
And if you choose to buy with cash, the car will be an asset. Why? Because you won’t owe anything on it anymore–and can sell it if you need to make some money quickly.
Put simply, you need to evaluate whether leasing or buying a car will put you in a better financial position.
Assets vs. Liabilities in Accounting
Usually, a company’s balance sheet is divided into two columns. You’ll list all the assets on the left side and your liabilities on the right. Correctly listing your assets and liabilities is a good bookkeeping practice. When you keep track of your assets and liabilities, you have a handle on your business's financial health—and also won’t miss important payments.
The difference between your total assets and total liabilities is the net worth of your business. Net worth or owner’s equity indicates the value of a business.
Here’s the accounting equation to calculate the worth of your business:
Equity = Total Assets - Total Liabilities
In other words, you need to have more assets than liabilities to have a higher worth.
Your investors and lenders may use this same equation while doing a business valuation—the process of evaluating a business’s total economic value.
Balance Your Assets and Liabilities for a Healthy Business
Assets and liabilities are two essential parts of any small business. They both help your business grow. While liabilities seem daunting, your business can’t operate and grow with zero liabilities. You may need to take a loan to buy necessary equipment or get inventory on credit.
Assets help you run your business smoothly, even when your earnings aren’t as high as expected. They give you confidence you can expand your business and set ambitious financial goals.
Now that you know all the basics about these two financial metrics, all that's left to do? Keep an eye on how your liabilities are growing and whether you have enough assets to repay them.