Assets form a very important component of a business. If a person is planning to start a business soon or already has one up and running, they would look to acquire assets to conduct their daily operations and/or for further expansion.
Maintaining financial stability by way of proper asset management increases their chances of success. Assets play a vital role in the smooth running of a business. Read the following to know more about asset meanings and the types of assets.
What is an Asset?
An asset is any resource with economic value that is owned or controlled by an individual, company, or government with the expectation that it will generate a positive benefit. Assets should be listed on the company’s balance sheet, and they are purchased or created to increase a firm’s value or benefit the firm’s operations. An asset can generate cash flow, reduce expenses, or improve sales, regardless of its type. Acquiring assets leads to the creation of liabilities for a business.
Assets vs. Liabilities
| Assets | Liabilities |
| Assets are anything of economic value that a company owns. | The debts a company owes to others are referred to as liabilities. |
| They provide a future economic benefit. | They reduce a company’s value and equity. |
| Examples: Cash, investments, inventory, etc. | Examples: Bank debt, mortgage debt, account payable, etc. |
What Are The Types of Assets?
It is essential to ensure that a company’s assets are properly classified on the balance sheet. Different types of assets are:
1. Current Assets
Current assets represent all the resources of a company that are expected to be effortlessly sold, consumed, used, or exhausted through standard business operations within one accounting period.
Few examples: Cash, cash equivalents, stock inventory, accounts receivable, and marketable securities.
Why are current assets crucial for a successful business? This is because they are used to fund daily business operations and pay unexpected operating expenses.
Some current assets in detail,
- Cash and Cash Equivalents: Cash and cash equivalents state the amount of all cash or other assets that are readily convertible into cash. Here, cash equivalents are short-term investments with a maturity period of 90 days or less than that.
- Accounts Receivable: This is the ‘balance of money due to a company for goods or services delivered or used but not yet paid for by the clients. When a company lets a buyer purchase their goods or services on credit, accounts receivables are created. “Accounts receivable turnover ratio” or “Days Sales Outstanding (DSO)” are used to analyze the strength of a company’s AR.
2. Fixed Assets
Fixed assets are long-term tangible assets (physical assets) that a company owns and uses in its operations to generate income. The widespread assumption about fixed assets is that they are expected to stay, be consumed, or be transformed into cash after at least one accounting period.
Few examples: Buildings, computer equipment, furniture, land, machinery, and company vehicles.
Fixed assets undergo depreciation, which divides a company’s non-current asset costs to expense them across the asset’s useful life. In accounting, there are two methods available for calculating depreciation. A company can use any of these methods depending on its needs. Some methods are:
- Straight-line method: Straight-line depreciation method spreads the expense evenly over the life of an asset. We can do this calculation by deducting the residual or salvage value (estimated resale value) from the asset cost, and then the amount is divided by the used lifetime (number of years).
- Accelerated method: Accelerated depreciation methods, such as double-declining balance (DDB), states that there will be higher depreciation expenses in the initial few years and lower cost as the asset ages.
3. Financial Assets
A financial asset is a liquid asset like stock equity or bank deposits that gets its value from a contractual claim or ownership on an underlying asset. This underlying asset can be a commodity or a piece of real estate.
Few examples: Stocks, bonds, mutual funds, and CD (Certificate of Deposit).Some financial assets in detail,
- Stocks: Stocks, financial assets, are the type of security that represents the ownership of a fraction of a company. When an investor buys stocks, they become part-owners of that company’s shares in its profits and losses.
- Bond: Private companies or governments issue bonds to finance their short-term projects. Here, the bondholder is the lender, and the bond states how much money is owed, the interest rate, and the bond’s maturity.
- Certificate of deposit (CD): CD allows an investor to deposit an amount of money in any bank for a specified period with a guaranteed interest rate. The depositors will receive a monthly interest. CDs can be held between three months to five years based on the contract.
Intangible Assets
An identified non-monetary asset with no physical existence is known as an intangible asset. Businesses can internally create their intangible assets or acquire other company’s intangible assets.
Few examples: Goodwill, patents, brand recognition, trademarks, and copyrights.
We can classify intangible assets as either indefinite or definite.
- Indefinite: Company’s brand name is an indefinite intangible asset because it stays with the company for as long as it continues its operations.
- Definite: Any legal agreement to operate under another company’s patent is a definite intangible asset because this agreement has a limited life.
For instance, if company A acquired a patent from company B for an agreed-upon amount of $10 billion, then company A would record that transaction in intangible assets that would appear under long-term assets.
What is the Asset Turnover Ratio?
The asset turnover ratio compares the value of a company’s assets to the value of its sales or revenues. It is a metric that measures how effectively a corporation uses its assets to produce income.
Asset turnover ratio = Total Sales / (Opening Assets + Closing Assets)
Here,
- Total sales = Annual Sales
- Opening Assets = Assets present at the start of the year
- Closing Assets = Assets at the end of the year
A higher value of asset turnover ratio means the company is generating revenue from its assets more efficiently. A low asset turnover ratio indicates the company is not efficiently using its assets to generate sales.
Conclusion
A solid understanding of assets and liabilities can help to make good financial decisions and evaluate the health of the business. Identifying assets and correctly valuing them is very vital in determining a business’s net worth.