Knowing about assets vs. liabilities gives companies and their investors a good idea about the company’s financial health. For any company, and any investor who invests in the stock of a company, offsetting liabilities (if any) against assets is the key to information about where a company stands in terms of its finances. This information may drive decisions of investment in a company and being informed is of the essence before investing.
Before understanding the differences between assets and liabilities, you have to know what each concept represents. In its simplest form, a company’s balance sheet is divided into the categories of “assets” and “liabilities”. Assets can be said to be financial resources that a company possesses or has a right to, which will benefit the company at a point in the future. Assets provide economic benefits in the future. On the other hand, liabilities could be said to be the opposite of assets in that they are things that a company owes to other individuals/parties.
It is important to differentiate between assets and liabilities, not only to proficiently read a company’s balance sheet but also to determine the extent to which a company is financially stable. If a company has more assets than liabilities, it is well-positioned in terms of its finances and may be considered investment-worthy. Assets and liabilities may be differentiated on many parameters and it is crucial to know these.
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The difference between assets and liabilities may become clear if you come across examples of assets and liabilities.
Examples of assets are investments, cash, office equipment, inventory, machinery, company-owned vehicles, real estate, etc.
Examples of liabilities are mortgage debt, bank debt, wages/salary owed, money owed to suppliers as accounts payable, taxes owed, etc.
The first thing to think about when you are discussing assets and liabilities is to know that assets generate value for a company. They increase the equity of a company. Liabilities only decrease a company’s equity. The more the assets of any company outweigh the liabilities, the more solid the financial health of a business will be. If there are more liabilities than assets, a company may find itself on shaky financial ground.
When you contrast assets vs. liabilities, you must consider the aspect of liquidity. This is a concept related to assets. Assets are frequently classified according to their liquidity. This translates to how quickly an asset can be converted to cash if the company needs capital. The most liquid of all assets is cash for a company. This is considered a current asset (as it can be made liquid very quickly or within a year), and the more a company has to spare, the more it can cover any liabilities that come up.
From what you have read so far, you may surmise that assets are revenue generators for any company, whereas liabilities take revenue away. The more marketable an asset is, the more revenue it can generate, and rapidly too. There are other assets, like fixed assets, which also add value to a company’s financials, like property, etc, but these may not be highly liquid. Still, it is better to have more of these than none, as they contribute to a company’s income but may not be held for cash conversion.
The differences between assets and liabilities can be understood by glancing at the table below:
|Meaning||Economic resources owned by a company, or that the company has rights to use||Obligations that a company is required to pay out in the future|
|Purpose||Generation of revenue||Financial obligation|
|Types||Fixed and current||Current and noncurrent|
|Examples||Land, patents, cash||Loans, accounts payable|
|Depreciation||Fixed assets may be subject to depreciation||Liabilities are not subject to depreciation|
|Cash Flows||The inflow of cash and increase in cash balances||The outflow of cash and decrease in cash balances|
|Balance Sheet||Appear on the right side of the balance sheet||Appear on the left side of the balance sheet|
For owners of a business, the most important goals may be to increase assets and decrease liabilities. An ideal scenario for any company would be to have no liabilities at all. Balancing the company books may be challenging for businesses, and the understanding of assets vs. liabilities comes into play. For investors, the key financial goal may be to maximize investment profit, and this is where assets vs. liabilities come into the picture as well. Investors who open a demat account and wish to invest in the stock market are essentially investing in the company and its future. They will likely consider a company with more assets than liabilities. While choosing an upcoming IPO, research by an investor may centre around the company’s assets and liabilities.