When running a company or a business, the profit and loss of the business is something you need to have a close eye one. There are various factors that play a part in this profit and loss. One of the most important of these factors is an asset. Asset in simple terms is a resource that is bought mainly to increase the value of the company. However, the term goes much deeper and to understand how important of a role an asset plays in a business and the different types of assets that have their own individual importance, let us go through this term in a little more detail.
What is an Asset?
You must have heard the term asset or read about it quite often in a business news article; but what exactly does this term mean? An asset basically is a resource that comes with an economic value and is owned or controlled by an individual, corporation or country in hopes that it will prove some future benefit to the entity. These assets are reported and displayed on the company’s balance sheet and are created or bought to increase the firm’s value or benefit the firm’s operations.
An asset is thought of as something that in future can generate cash flow, reduce expenses or improve sales irrespective of whether it is production equipment or patent. It is an economic resource for a company, individual or firm or represents access that is not open to other individuals, companies, or firms.
A right or other access is legally enforceable, which implies that the economic resources can be used at the discretion of the company and its use may be restricted or precluded by an owner. A company needs to possess a right to an asset from the date of financial statements in order for an asset to be present. An economic resource is important for a company as it is something that is scarce and has the ability to produce economic benefits by generating incoming cash flows and reducing the outgoing cash flows.
To know if something is an asset you need to consider it on the following parameters— it must be something owned by you, it can also be something owed to you, it should be an economic resource that provides current, future or potential economic benefit. Let us go through an example to understand this a little better. For example, if someone owes you a loan of a certain amount, that loan amount can also be considered as an asset for you as the person owing the loan is going to pay you back with interest, which brings you a future economic benefit. At the same time, that said loan amount becomes a liability to the person who is paying you back. This example is also a simple way to understand the basic difference between an asset and a liability. Along with physical assets, there are a lot of non-physical or intangible assets that you need to understand. These assets are something that work similar to the physical assets by providing you economic benefit but cannot be touched. Intangible assets are an important class of assets and include things like patents or trademarks that are known as intellectual property, contractual obligations, royalties, and goodwill. Other intangible or non-physical assets that can be quite beneficial and valuable are brand equity and reputation. Financial assets like shares of stock or derivatives contracts can also be classified under intangible or non-physical assets.
When it comes to assets, a common confusion that goes around is that many people seem to think that labor also is an asset, which is not true. Labor cannot be considered as an asset as it is carried out by human beings who are paid in wages or salary for their work.
Assets are broadly classified into short term (or current) assets, fixed assets, financial investments and intangible assets.
Types of Assets
Now that we know what assets are and how important they are for a business, let us go through the different types of assets to understand them on an individual level. As discussed above, assets can be divided into four types—short term or current assets, fixed assets, financial investments and intangible assets. We will go through these one by one for a better understanding.
Short term or Current assets Short term or current assets are short term economic resources that are expected to be converted into cash within a period of one year. These assets include cash, equivalents of cash, accounts receivable, inventory and prepaid expenses. Accountants have to periodically assess the recoverability of inventory and accounts receivable, whereas cash is fairly easy to value. In cases where the inventory becomes obsolete, the company will write off these assets or if the accounts receivable are uncollectible, it becomes impaired and of no use.
Fixed assets As opposed to current assets, fixed assets are long term resources which include plants, buildings and equipment. Depreciation or periodic charges are considered when making adjustments for the aging of these fixed assets. This may or may not reflect the loss of earning power for a fixed asset.
Financial Assets Financial assets represent investments in other institutions’ properties and shares. These financial assets include corporate bonds, stocks, sovereign bonds, preferred equity, and other hybrid securities. The financial or economical assets are valued considering the motive behind the said investment and how the investment has been categorised.
5. Intangible or non-physical assets
Intangible assets which are also commonly known as non-physical assets are the assets that have no physical value. These are economic resources in the form of patents, trademarks, copyrights, royalties, contracts, and goodwill. Accounting for these intangible or non-physical assets differs depending upon the type of the asset. Such assets are usually amortized or tested for impairment every year.
All the above types of assets have their individual importance and are used by individuals, companies and firms for different purposes with one common aim of gaining current, future or potential economic benefits from them.