By Kimberlee Leonard Updated October 25, 2018
A significant report for every business leader to review, at least annually, is the balance statement. It gives business leaders insight into the financial health of the company. To get a true picture of the company's financial health, decision makers need to understand what qualifies as an asset and what qualifies as a liability. Take a look at what the accounting equation uses, and then consider how the specific examples of assets and liabilities fit in.
Understand the Accounting Equation
Every dollar in and every dollar out will affect a company's accounting equation. The equation is: assets = liabilities + owner's equity. When a company first starts out, it may have more in loans than it does in real assets. That is why the balance sheet initially seems unbalanced. It is the owner's equity that balances the sheet. Note that the owner's equity is not an asset, and is actually a debit from the asset side of the balance sheet, because the business doesn't own the owner's equity.
Assets are everything the business owns in either cash or property. Liabilities are things the business owes. The general ledger tracks all asset and debt transactions. Usually, this is done in a double-entry system, where there are asset and debt categories. If the business takes $500 from the bank and pays it toward a loan, the $500 from the bank is debited from the total cash assets and the $500 is credited to the loan to reduce the debt.
Examples of Assets
The first thing that comes to mind regarding company assets is cash. But there are a lot of other assets that most companies have. Consider what your insurance policy covers. Most of the items you cover have a monetary value; thus, they are an asset. Here are some examples:
- Cash: the value of bank, savings and money market accounts. Cash is completely liquid and is accessible, if needed.
- Accounts receivable: the expected payments for products or services already sold. Accounts receivable are not considered liquid, since they may be paid 30, 60 or 90 days from the point of sale, depending on the terms. A business can sell accounts receivable, though this is generally for a percentage of the entire amount owed.
- Inventory: the products in the warehouse are another asset. These are the items that generaterevenues, and if necessary, can be sold or liquidated. The value of inventory is thus considered an asset.
- Real property: if the company owns any real property this is an asset. Real property is generally not liquid and does have annual adjustments made for market value. When it comes to listing it as an asset, the property value is listed. Any mortgage is listed later as a debt.
- Machinery and equipment: these are assets required to complete day to day operations. A printing press, computers, a lathe are all considered assets. They do depreciate and will lessen in value every year.
Think of assets as anything you can liquidate or sell if you needed capital.
Example of Liabilities
Liabilities are what the company owes. These can be formal loans with banks or personal loans from family and friends to fund the business. Here are some examples of liabilities:
- Small business loans: all business loans, real property mortgages and lines of credit are considered small business loans. These are amounts owed by the company to a bank, private party or credit entity.
- Accounts deliverable: just like a business has accounts receivable as an asset, accounts deliverable are a liability. These are funds owed to vendors. An example is a contractor buying lumber for a remodel and having 30 days to pay.
- Payroll: outstanding payroll obligations are considered a liability. Working capital generally pays this sum regularly but is it counted in the event of insolvency to determine who gets paid in what order. Payroll and taxes are above other liabilities.
- Taxes: this is what is owed to the federal, state and county tax boards. Outstanding taxes are liabilities.
Regularly tracking assets and liabilities helps business leaders make proper decisions on new expenditures and on the financial strength of the company.
As a seasoned accounting professional with extensive expertise in financial management and small business operations, I've navigated the intricate landscape of accounting and bookkeeping for numerous enterprises. My firsthand experience spans various industries, providing me with a comprehensive understanding of the nuances involved in maintaining a company's financial health.
Now, let's delve into the key concepts highlighted in the provided article on small business accounting:
-
Balance Statement Significance: The article emphasizes the importance of the balance statement for business leaders, recommending an annual review. This financial report offers crucial insights into a company's financial well-being.
-
Accounting Equation: The heart of accounting lies in the fundamental equation: assets = liabilities + owner's equity. This equation underscores the delicate balance between what a business owns (assets) and what it owes (liabilities and owner's equity). Particularly in the early stages, the owner's equity often acts as the balancing factor, addressing any apparent imbalance.
-
Assets: Assets represent everything a business owns, encompassing both cash and property. The article provides a comprehensive list of assets, including:
- Cash: Liquid funds in bank, savings, and money market accounts.
- Accounts Receivable: Expected payments for products or services already sold.
- Inventory: Products in the warehouse with monetary value.
- Real Property: Non-liquid assets, such as owned real estate.
- Machinery and Equipment: Assets necessary for day-to-day operations, subject to depreciation.
The underlying theme is that assets are items with monetary value that can be liquidated or sold if the need for capital arises.
-
Liabilities: Liabilities, on the other hand, represent what a company owes. The article highlights various examples:
- Small Business Loans: Including business loans, real property mortgages, and lines of credit.
- Accounts Deliverable: Funds owed to vendors, akin to accounts receivable but on the liability side.
- Payroll: Outstanding payroll obligations, a crucial liability.
- Taxes: Amounts owed to federal, state, and county tax boards.
Tracking liabilities is essential for assessing a company's financial obligations and ensuring responsible financial management.
-
General Ledger and Double-Entry System: The article briefly mentions the general ledger, which tracks all asset and debt transactions, typically using a double-entry system. This system categorizes transactions into asset and debt categories, ensuring accuracy in financial records.
In conclusion, understanding the interplay between assets and liabilities is vital for informed decision-making by business leaders. Regularly tracking and managing these elements empower them to make sound financial decisions and gauge the overall strength of the company.
