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Assets and liabilities are terms generally used in business and accounting. A company’s balance sheet keeps track of both assets and liabilities, and the difference between them is equity of that business.
A company should always try and keep its liability-to-asset ratio between 0.3 and 0.6. A liability-to-asset ratio shows how much of a company’s assets consist of liabilities. A higher L/A ratio shows the company efficiently utilises its assets. Here’s a detailed idea about assets and liabilities.
Assets are everything that a business owns and can be economically beneficial in the future.
There are two types of assets – current and fixed.
Current assets are those which can be promptly converted to cash. These can include inventory, cash and accounts receivables.
Fixed assets are the equipment and items a company owns which are long-lasting and valuable to the company. For example, computers and machinery are fixed assets for a company.
Assets can also be categorised as tangible and intangible assets. Tangible assets have a physical form, and one can see, feel and touch them. Examples can include machinery, vehicles, etc. Intangible assets exist without any physical presence but have immense value. Examples can be copyright, royalty, etc.
Based on the usage, there are another segmentation of assets – operating and non-operating assets.
As the name suggests, the operating asset is used to maintain daily operations and generate revenue. Examples include office buildings, machinery, equipment, etc.
Non-operating assets, on the other hand, are not used to maintain daily operations but aid in generating a significant amount of revenue. Examples include short-term deposits, land, income earned from fixed deposits, etc.
Given below is the list of assets:
Liabilities are debts a business owes in the immediate or further future. It is inevitable that all businesses have liabilities.
There are two categories of liabilities- current and long-term liabilities.
Current liabilities are debts that the company intends to pay back within a year. It can include credit lines, salaries, loans and accounts payable. Long-term liabilities are usually paid back after one year. It can include mortgages and bonds.
There is another type of liability that is contingent liability.
Contingent liabilities are debts or obligations which a business does not experience during the course of its operation. Business corporations mention contingent liabilities as a footnote in the balance sheet. Guarantees for loans, lawsuits, and claims against product warranty are examples of contingent liabilities.
Given below is the list of liabilities:
In simple words, assets and liabilities are just opposites of one another. To make the concept more clarified, the table below furnishes the differences in detail:
|Assets are economically beneficial for an organisation.||Liabilities are an obligation for an organisation.|
|Assets = liabilities + shareholder’s equity||Liabilities= assets – shareholder’s equity|
|Assets generate cash inflow for a business.||Liabilities cause cash outflow for a business.|
|Different kinds of assets are current, fixed, tangible and non-tangible.||Different types of liabilities are contingent, current and non-current liabilities.|
|Assets are depreciable.||Liabilities are non-depreciable.|
Assets and liabilities both contribute to an organisation’s sustainability. Liabilities are, in some ways, an outcome of the company’s assets and transactions. Hence, you should know how to keep the balance between these two to maintain a healthy financial ratio.
To understand how these two are interrelated, here are brief discussions of some financial ratios at a glance.
Current ratio = current assets/ current liabilities
The higher this current ratio, the better situation a company is in, in terms of liquidity. A high current ratio signifies that the company is currently flourishing under the current circumstances.
Debt ratio = total liabilities/ total assets
A company can calculate how much of its assets were financed by the existing debt by deriving the debt ratio value.
Cash ratio = cash and cash equivalents/ current liabilities
Similar to an acid test ratio, a cash ratio helps a company to measure its ability to pay off short-term debts with cash and cash equivalents.
Owner’s equity = total assets – total liabilities
The owner’s equity is the company’s value after subtracting its liabilities from the assets. And it is vital for a company to use the owner’s equity to efficiently manage the liabilities and assets.
Acid test ratio = (current assets – inventories)/ current liabilities
A company can assess its ability to pay off the short-term liabilities with its quick assets by conducting an acid test ratio.
In a nutshell, both assets and liabilities of a business are crucial indicators that show its financial health in terms of liquidity, debt repayment, etc. It also allows prospective investors to get a clear idea about how profitable it would be to invest in a particular business.