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What is an asset?
An asset is a physical or non-physical item of economic value owned by a business. These items help the business to create economic value and generate revenues. Assets are shown on a company’s balance sheet to determine a company’s financial position on a given day. For example, a business invests in machinery intending to provide future benefits in the form of higher revenues (due to increased production).
Return on equity: Highlights
- Assets are valuable resources owned by a business, expected to create economic benefits for a business.
- Assets include plant, property, goodwill, inventory, cash, marketable securities, etc.
- There are various types of assets, such as current assets, non-current assets, tangible assets, intangible assets, financial assets, etc.
Importance of assets
Assets provide economic or monetary benefits to a business. There may be operating assets, non-operating assets, leased assets, etc. For example, inventory is a type of operating asset, and fixed deposits are a type of non-operating asset. There may also be personal or company assets depending on the ownership and use of the assets. For instance, a car might be a personal asset but is considered a company asset when purchased for business operations.
Also, an asset for one company might not be an asset for another. For example, furniture can be an asset for a cement company but not for a company dealing in furniture.
Additionally, assets also provide a competitive advantage to companies and help them gain market share. For instance, the strategic position of a mine can help a mining company earn a competitive edge over other companies. Similarly, access to a range of exclusive software is an asset for an IT company.
Types of assets
Assets can be categorised in the following ways-
- Duration
- Current assets
Current assets are short-term assets that can be converted into cash within a financial year. These are usually recurring as they occur due to the day-to-day operations of a business. For example, marketable securities, inventory, accounts receivables, etc.
- Non-current assets (Fixed assets)
Non-current assets are long-term assets that cannot easily be converted into cash or cash equivalents within a financial year. The value of these assets cannot be consumed in a year. Thus, these assets are capitalised. There is usually a certain depreciation or amortisation rate charged on such assets. For example, PPE (Property, plant and equipment), copyrights, trademarks, etc.
- Physical existence
- Tangible assets
Tangible assets or physical assets are assets that have a physical existence. These assets usually help in running the core operations of a business. For example, a steel manufacturing company owns a steel plant for production.
- Intangible assets
Intangible assets do not have any physical existence. These assets can either be created or acquired. Only acquired intangible assets are recorded in the books of accounts. Internally generated intangible assets are not recorded in the books of accounts. For example, a company’s brand reputation is not recorded on the balance sheet.
- Financial assets
Financial assets are those assets that arise due to contracts or ownership. For example, stocks, bonds, bank deposits, mutual funds, etc. They are usually valued at market prices and are held for investment purposes.
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What are examples of assets?
Some examples of assets are machinery, equipment, property, goodwill, intellectual property, cash, marketable securities, prepaid expenses, inventory, goodwill, royalties, deferred tax assets, etc.
Is labour an asset?
No, labour is not an asset for the company.
Labour provides economic value to a business and might also provide a competitive edge. However, assets are owned by the company, and labour cannot be owned by any business. Furthermore, labour is compensated through salaries and wages, which are expensed and thus, labour cannot be treated as an asset.
Current assets vs non-current assets
| Current assets | Non-current assets |
| These assets can be easily converted into cash and cash equivalents. | These assets cannot be easily converted into cash and cash equivalents. |
| These assets are short-term assets. | These assets are usually held for a longer duration (more than a financial year). |
| Such assets do not have any depreciation or amortisation. | These assets are depreciated/amortised. |
| The value of current assets is drawn for one year only. | The value of fixed assets is spread over the number of years the asset will be used. |
| Example- prepaid expenses, inventory, accounts receivables, etc. | Example- plant, property, equipment, goodwill, etc. |
What is the difference between assets and liabilities?
| Assets | Liabilities |
| Assets are items that provide economic value to the business. | Liabilities are debts that the business owes to external parties or outsiders. |
| Assets help conduct business operations such as generating revenues, increasing profits, etc. | Liabilities help finance business operations, such as manufacturing a product and more. |
| Acquiring assets usually results in cash outflows. | Incurring liabilities usually result in cash inflows. |
| As per the accounting rules, assets are debited. | As per the accounting rules, liabilities are credited. |
| Example- machinery, accounts receivables, prepaid expenses, etc. | Example- loans, accounts payables, accrued expenses, etc. |
Comparison: Current assets, liquid assets, and absolute liquid assets
| Current assets | Liquid assets | Absolutely liquid assets |
| The degree of liquidity of current assets is comparatively low. | The degree of liquidity of liquid assets is comparatively moderate. | The degree of liquidity of absolute liquid assets is comparatively high. |
| It includes cash, cash at the bank, marketable securities, inventories, accounts receivables, and prepaid expenses. | It includes cash, cash at the bank, marketable securities, and accounts receivables. | It includes cash, cash at the bank, and marketable securities. |
Importance of asset classification
Assets depict the financial health of a company.
Thus, the classification of assets is essential to determine a company’s liquidity position, solvency, and risk. Classification into current assets and fixed assets helps in planning for working capital requirements and also in knowing the long-term financial position of a company.
Conclusion
Assets, in simple words, are the resources that a company owns. These assets can be of various types depending on their nature, liquidity and more. Assets determine a company’s financial position and can help predict growth and risk. It is paramount to understand what assets are to help decipher a company’s standing.
