What Are Assets and Liabilities? Meaning, Types and Differences

Assets and liabilities are essential factors that help evaluate the performance, profitability and long-term sustainability of a company/business. While on one hand assets represent everything that a company owns (all things that have value attached such as property, equipment, intellectual property). On the other hand, liabilities refer to obligations and debts that the company owes to other companies, in the forms of loans, accounts payable etc.

Through this comprehensive blog, we’ll understand the meaning of these two essential concepts- assets and liabilities in accounting along with their various types, and their differences.

What are Assets?

Assets refer to any resource owned by a company that can be used to generate income or future revenues. Being convertible into cash or cash equivalents, an increase in these assets leads to higher profits and improved cash flow for the company that can further be useful in repaying loans or investing in equipment or other valuables.

In accounting, assets include everything from cash and investments to physical items like equipment and inventory. For example, raw materials held by a company are considered assets because they can be transformed into finished products, which can then be sold to generate revenue. Some other examples of assets include- cash, inventory, investments, machinery, office equipment, real estate, vehicles owned by companies etc.

Assets for the company can be calculated using the formula:

Total Assets= Liabilities (accounts payable) + Owner’s Equity

Types of Assets

Assets can be divided into three broader categories as mentioned below:

Based on Convertibility

• Fixed Assets- these are not easily convertible to cash. Some of the fixed assets include land, buildings, machinery and equipment.
• Current Assets- these can be quickly and easily convertible into cash. Current assets include cash or cash equivalents, securities, stocks and so on.

Based on Physical Existence

• Tangible assets- these are physical assets that can be touched or seen. Examples include buildings, equipment, and machinery.
• Intangible assets– these do not have a physical presence but still possess value. Examples include copyrights, permits, and trade secrets.

Based on Purpose of Use

• Operating assets- these directly contribute to generating revenue and support the daily operations of the business. Examples include cash, buildings, machinery, and equipment.
• Non-operating assets- these aren’t used in the day-to-day operations, but they still generate income. Examples include short-term investments and vacant land.

What is Liability?

Liability refers to any financial obligations that a company or organization must fulfill. It comprises all types of accounts payable that includes the amounts owed to others. On a company’s financial statements, liabilities are listed on the right side of the balance sheet and provide a detailed overview of the company’s obligations, including short-term debts (current liabilities) and long-term debts (non-current liabilities).

For instance, businesses often take on liabilities such as loans or trade credit to fund expansion projects or manage cash flow. Some other examples of liabilities include bank debt, mortgage debt, money owed to suppliers, wages and taxes owed.

Liabilities of a company can be calculated using the formula:

Total Liabilities= Assets (Account Receivable) – Owner’s Equity

Types of Liabilities

In accounting, liabilities are classified into two types-

• Internal Liabilities- Includes obligations within the company, such as capital, retained earnings, and employee salaries.

• External Liabilities- Includes obligations owed to external parties, such as taxes, bank overdrafts, creditors, and loans.

As per their functions, liabilities can be further divided into three categories-

• Current Liabilities- These are short-term obligations that a company needs to pay off within a year. Examples include bills, trade creditors, and bank overdrafts.

• Non-Current Liabilities- These are long-term debts that are due over an extended period. These are often used by companies for growth or purchasing fixed assets. Examples include debentures, long-term loans, and bonds payable.

• Contingent Liabilities- These are potential obligations that may arise depending on future events or outcomes. Examples include product warranty claims and lawsuits.

Difference Between Assets and Liabilities

Below mentioned are crucial difference between assets and liabilities according to various parameters-

Relationship between Assets and Liabilities

In order to sustain a company’s profitability, there must be a balance between total assets and liabilities. This further allows you to assess the company’s ability to manage external as well as internal obligations and its capability to convert assets into cash equivalents. Understanding the relationship between assets and liabilities also helps to determine the liquidity ratio of the business that influences important financial decision making that will impact the company’s overall value and financial position in the market.

Below mentioned is a list of financial ratios with their descriptions and formulas that you must know to understand company’s assets and liabilities-

Thus, a company’s assets and liabilities play a significant role in assessing its liquidity, ability to repay debts, and overall profitability and serve as key indicators for estimating a company’s financial well-being and future position in an ever-evolving financial market. Therefore, it’s important to evaluate the company’s assets and liabilities for making the most favorable financial decision.