Macro Moves

Assets vs Liabilities: What's wrong with your Balance Sheet?

Created on 27 Aug 2022

Wraps up in 6 Min

Read by 1k people

Updated on 12 Sep 2022

Growing up, we all had terrible management of our pocket money, and therefore most of us would often spend more than our needs and then end up broke before the end of the month. It seemed like we had an eternally cursed wallet, but you're mistaken, my friend. 

The writer and speaker Ralph Waldo Emerson once said, "Money often costs too much". But little did we know that the cost would soon become a suitable investment. A good investment can save us from burdensome debt and even profit our pockets. 

Therefore, having a good understanding of the market and experience in dealing with investments is vital. But where do we start? Assets and liabilities usually form the base of any business. So, having a clear understanding of assets and liabilities can help you build your life from scratch, like Anushka Sharma and Ranveer Singh in Band Baaja Baaraat, who managed the expenses of their venture so nicely that it turned profitable.

Well, assets and liabilities are found in our daily lives, and maintaining a healthy balance between these two can be a lifeline! So, read ahead to know more about them and their impact on our finances.

What are Assets? 

Assets are profitable resources for our business and help it grow in value with each passing financial year. These resources help increase your company's revenue and maintain its financial health by ensuring a better inflow of money. 

Assets are resourceful for us because they promise an increased cash flow as their value appreciates with time. They act as an alternative solution for debt. Moreover, while formulating a balance sheet, the assets are calculated and directly influence our net worth. Adding to that, the assets help increase the company's equity. 

For instance, let's assume you lend someone a considerable amount to start a restaurant at a specific interest rate. This outflow of money here is an asset since, in the future, you get the principal and the monthly interest on the lent amount. 

To better understand how an asset is the complete opposite of a liability, recall Robert Kiyosaki's quote, "Assets put money in your pocket, and liabilities take money from your pocket." 

Type of Assets:

Your I.Com. textbook categorizes assets into the following types:

1. Current Assets:
Assets that can be converted into cash quickly, ideally, in less than a year, are called current assets. Example:  Cash, advance payments for tax. 

2. Fixed Assets:
Assets that are not converted into cash quickly are called fixed assets. Example: Real estate, Machinery. 

3. Tangible Assets:
Assets that have physical existence are called tangible assets. Example: Equipment, Inventory.

4. Intangible Assets:
Assets that do not have physical existence are called tangible assets. Example: Logos and trademarks owned by the company. 

5. Deferred Tax Assets:
Assets that reduce the company's taxable income are called deferred tax assets. Since these assets are found when the company overpays the taxes, they return to the business as tax relief. Example: Tax overpayment, Business Expenses.

What are Liabilities?

Parallel to assets, liability is the outflow of cash or debts. Liabilities are burdens for oneself and your company since they drain away your money. 

When we owe money to someone, it becomes a liability for us and is not considered profitable because liabilities add to the outflow of money. Moreover, if we buy more assets through short-term debts, adding more liabilities to your balance sheet is still counterintuitive. 

Are you still a bit confused? To better understand, let us consider a situation where you buy a property on a mortgage. Now, the property is an asset as the values in real estate usually appreciate. However, on the other hand, the mortgage for the property forms a liability for us. 

Type of Liabilities: 

Your I.Com. textbook categorizes liabilities into the following types:

1. Current Liabilities:

Liabilities for a short term and payable within one year are called current liabilities. Example: Taxes and bills

2. Long-term Liabilities:
Liabilities for a longer term and not payable until the next year are called long-term liabilities. Example: Car Loans and Mortgage

3. Deferred Tax Liabilities:
Liabilities that are due in future are called deferred liabilities. Since these payments will be paid in the future, they are a liability. Example: Deferred Income Tax, Deferred Revenues.

The first paper money was made 1200 years ago by the Chinese.

Assets Vs liabilities

 

Assets 

Liabilities 

Definition

Items that increase the company's value.

Items that the company owes and decreases the cash inflow.

Role

Help in revenue generation.

They drain the funds of the company.

Purpose

Increase the equity of the company and strengthens the financial hold.

Though debt needs to be paid off in the future, it can be used to buy more assets.

Types

Types of assets are fixed, current, tangible and intangible.

Types of liabilities are long-term and current.

Examples

Land and Cash

Loans and Mortgages.

Depreciation

Fixed assets can depreciate in the future.

Liabilities do not depreciate at all.

Calculation

Assets = Liabilities + Equities 

Liabilities = Total assets - Equity

Balance Sheet

Assets are placed on the right side of your company’s balance sheet.

Liabilities are placed on the left side of your company’s balance sheet. 

How do assets and liabilities impact our finances?

Assets and liabilities impact our finances more than we think. It is because they can have a direct effect on our finances. Its impacts are as follows:

1. Cash Flow Statement:

The Cash Flow Statement of our finances helps to measure the amount of money that comes in and goes out. Through this statement, you can calculate the cash flow, which can help you determine your company's equity. For instance, the more assets you have, the better your company valuation is; hence, the share prices increase too, compared to a downfall caused by excess liabilities. 

2. Balance Sheet

A balance sheet is a subtype of a personal cash flow statement, but it shortens the calculation to a specific period in time. Usually, this statement only includes the assets and liabilities and the net worth calculated after subtracting the liabilities. Through this calculation, we can identify the condition of our finances. If we have more liabilities than the asset, we have to pay more cash than we owe and vice versa. Such analysis can help us to formulate the right financial plan.

3. Understanding the investment

I can assume quite easily that we all have made good and bad investments, and we are guilty of making them many times. However, what sets us apart from the rest is our understanding of our past investments and not repeating them. Learning how assets and liabilities impact our finances can help us reach our financial goals much faster. 

4. Net Worth

Net worth is the difference between liabilities and assets. It helps us to understand whether we are in profit or loss. The company's net worth is easily affected by the slightest fluctuation between assets and liabilities. So, we must go through your balance sheet often and adjust our expenditure to incline it towards the assets side if it does not have a positive net worth.

The Bottom Line

Assets and liabilities are never really found in equilibrium in anyone's life. However, keeping track of where your money goes can save you from future debt and worry. And as Warren Buffet once said, "If you don't find a way to make money while you sleep, you will work until you die," Therefore, create as many assets as possible to have passive income sources.

Also, having a better understanding of how spending a penny on short-term pleasure without any worries of debt can save your entire wallet–and even add to it!  

So, what are your thoughts about the assets and liabilities? We would love to hear your experiences in the comments below!

An Article By -

Pratiksha Mahawar

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Sugar, spice & everything nice, that's what Pratiksha is made of. This proactive human, who is also a PhD scholar, makes difficult things look easy through her amazing skill of managing everything, be it professional or academic. Let’s not forget how this “Potterhead” makes room for her ‘occasional writing’ hobby while she leads marketing activities at Finology. 

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