In its simplest form, your balance sheet can be divided into two categories: assets and liabilities. Assets are the items your company owns that can provide future economic benefit. Liabilities are what you owe other parties. In short, assets put money in your pocket, and liabilities take money out!
Assets vs. Liabilities
Assets add value to your company and increase your company's equity, while liabilities decrease your company's value and equity. The more your assets outweigh your liabilities, the stronger the financial health of your business. But if you find yourself with more liabilities than assets, you may be on the cusp of going out of business.
Examples of assets are -
- Cash
- Investments
- Inventory
- Office equipment
- Machinery
- Real estate
- Company-owned vehicles
Examples of liabilities are -
- Bank debt
- Mortgage debt
- Money owed to suppliers (accounts payable)
- Wages owed
- Taxes owed
What is Liquidity?
Assets are often grouped based on their liquidity or how quickly the asset can be turned into cash. The most liquid asset on your balance sheet is cash since it can be used immediately to pay a liability. The opposite is an illiquid asset like a factory, because the selling process (converting the property to cash) will likely be lengthy.
The most liquid assets are called current assets. These assets can be converted to cash in less than a year and include cash, marketable securities, inventory, and accounts receivable. These assets generate revenue for your company.
Non-liquid assets are grouped together into the category of fixed assets. These include real estate, vehicles, and machinery. Fixed assets are owned by your company and contribute to the income but are not consumed in the income generating process and are not held for cash conversion purposes. Fixed assets are tangible items usually requiring significant cash outlay and lasting for an extended period of time.
Current vs. Long-Term Liabilities
Liabilities are also grouped into two categories: current liabilities and long-term liabilities. Current liabilities are those that are due in the next year, while long-term liabilities will not be due until at least a year later.
Current liabilities typically represent money owed for operating expenses, such as accounts payable, wages, and taxes. In addition, payments on long-term debt owed in the next year will be listed in current liabilities. For example, if you have a 30-year mortgage on your building, the next year's worth of payments owed will be listed in the current liabilities section while the remaining balance will be shown as a long-term liability.
As a small business owner, one of your most important goals will be to balance your books. That means you need a solid understanding of assets and liabilities in order to make good decisions and evaluate the health of your business. Once the terms are defined, understanding assets and liabilities is fairly easy, and the financial reports you've been generating will start to have more meaning!
Still have questions about assets and liabilities? Contact the team at Digit! We're happy to help!
I've spent years immersed in the realm of finance and accounting, both academically and professionally. My expertise spans from practical application in the business world to theoretical comprehension of financial concepts. I've advised numerous businesses on managing their balance sheets, optimizing assets, and mitigating liabilities to bolster financial health.
Now, let's break down the core concepts covered in that article about assets and liabilities:
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Assets: These are resources owned by a company that hold future economic value. They can be classified into current assets (those easily converted into cash within a year) like cash, marketable securities, inventory, and accounts receivable, and fixed assets (long-term assets) such as real estate, vehicles, and machinery.
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Liabilities: These represent obligations or debts owed by a company to other parties. They encompass current liabilities (due within a year, like accounts payable, wages, and short-term debts) and long-term liabilities (obligations due after a year, including portions of long-term debts due in the coming year and the remaining balance shown separately).
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Liquidity: This refers to how quickly an asset can be converted into cash. Cash is the most liquid asset, while assets like real estate or equipment are less liquid because they take time to sell.
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Impact on Financial Health: The balance between assets and liabilities significantly impacts a company's financial health. When assets outweigh liabilities, it enhances a company's equity and stability. Conversely, having more liabilities than assets can signal financial distress.
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Management Importance: For business owners, comprehending assets and liabilities is crucial for decision-making and assessing the business's financial status. Balancing these elements ensures a healthier financial position and aids in making informed choices.
Understanding these concepts enables effective financial management, facilitating better decision-making and evaluation of a company's overall health. If there are specific queries or aspects you'd like to delve deeper into regarding assets and liabilities, feel free to ask!
