Even if you don’t have a business or accounting or financial background, you would have heard the terms assets and liabilities. These terms are mostly in use in the financial and accounting world but are often used in non-financial context as well. Their non-financial use we will discuss later. But, talking about their financial use, they are the most important terms for businessmen. Therefore, understanding the meaning, importance, and application of assets vs liabilities is crucial to managing a business properly. To understand the meaning, importance, and application of assets vs liabilities, we need to see their differences.
Assets vs Liabilities – Differences
Following are the differences between assets vs liabilities:
Assets are the items that a company owns or has the right to use. These assets carry a specific value, and a company can use them to pay a debt or any obligation. On the other hand, Liabilities are an obligation for a business or an individual that they need to pay in the future.
Assets are a company’s financial resources that will eventually provide economic benefits to a company. They help in generating revenue for a company. On the other hand, Liabilities are the financial obligations that a company needs to pay sometime in the future.
Usually, there are two types of assets – fixed assets and current assets. There can also be tangible and non-tangible assets. There are two types of liabilities as well, current Liabilities and non-current liabilities. Also, there could be short and long-term liabilities.
Some examples of assets are machines, land, goodwill, accounts receivable, and more. A few examples of liabilities are the account payable, loans, and more.
Most assets depreciate over their useful life. Specifically, the fixed assets lose their accounting value over their useful life. Liabilities, on the other hand, are non-depreciable.
How to Calculate?
We can calculate assets by adding Liabilities and Owner’s Equity. We need to subtract the Owner’s Equity from Assets to calculate liabilities.
If there is an increase in an asset, it is debited. On the other hand, any increase in liability is credited. Similarly, any decrease in the asset is credited, and the liability is debited if there is any decrease in it.
Relation to Cash Flow
Assets result in cash inflow for a company over the years. On the other hand, Liabilities lead to cash outflow over the years.
In the balance sheet, assets come on the right side and liabilities on the left side. Further, current assets come first and then non-current assets. Similarly, current liabilities come first and then non-current liabilities.
A business is efficient if it is able to convert the assets into cash or into revenue streams. On the other hand, as per say, a business that pays its liabilities on time is efficient.
Above we said that assets and liabilities have non-financial use as well. This use is primarily due to the meaning of both these terms. For instance, if a person does well or is useful for a company, society, or even family, then they are usually referred to as an asset for the company, society, or family. On the other hand, if the person is not contributing anything but consumes resources, they are a liability.
Both assets and liabilities play a crucial role in the functioning or operations of the company. A business can’t survive without either of the two. If a company utilizes assets efficiently and uses the liability to acquire more assets, then it would be able to survive in the long run. They (assets and liabilities), along with the balance sheet, help in deciding the financial position of a company at a particular date. Not just for a company, both these terms are important for an individual as well. Understanding both these help individual manage their resources better.