Assets vs. Liabilities: Definitions and Differences
By Indeed Editorial Team
Published June 17, 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
On a balance sheet, there are typically two categories showing the company's assets and liabilities. The assets are the items of economic value that the company owns, while the liabilities are the debts the company owes to others or items that can negatively affect the company's value. As a professional accountant or financial analyst, understanding these two terms and their differences can be key to determining any company's financial health and status. In this article, we define assets and liabilities with examples, explain the different types of assets and liabilities, and discuss the differences between a company's assets and liabilities.
Assets vs. liabilities definitions
To understand assets vs. liabilities, it's helpful to first review the definition of each:
What is an asset?
An asset is an item the company owns that adds value to its worth and can provide future economic benefits to the company. Companies can increase their worth by acquiring more assets, and it's important that they accumulate and monitor their assets to facilitate business growth. An example is when a logistics company purchases bikes to add to its services rather than hiring them from other logistics businesses. The bikes retain their value for at least five years, providing the company with five years of value. Therefore, they're assets that contribute to the company's worth.
Here are some examples of common company assets:
What is a liability?
A liability is a debt that the company owes. Liabilities take away from the company's value, making it important for companies to limit their liabilities as much as possible. They're also items that have no or negative growth potential that could negatively affect the company's worth. For instance, a logistics company encounters some problems that affect its operations. Because it doesn't have enough money to fix the problems, it takes out a loan, knowing that its future sales of logistics services are enough to pay it back and nullify the liability.
Some examples of liabilities include:
the salaries the company owes its employees
the money the company owes to suppliers
taxes the company owes
Types of assets
There are several types of assets depending on the type of item and how the company uses it. They include:
Current assets are also short-term assets, and they're those items the company can consume or convert to cash within a year. This type of asset is anything the company can quickly sell in a financial emergency or use to purchase required goods. They're important because they provide the company with a quick way to get money to clear current business expenses. They include items such as:
Non-current assets are items that provide the company with revenue for an extended period. Financial analysts also call them fixed or long-term assets. These assets provide value to the company from a year upwards, and the company can't easily convert them into cash equivalents. Unlike current assets, non-current assets can be tangible or intangible.
Tangible fixed assets: These include items like land, buildings, company vehicles, furniture, tools, and equipment.
Intangible fixed assets: These include the company's intellectual property, patents, copyrights, and trademarks.
There are two categories of investment assets depending on how they generate income for the company. These are:
These are the company's investments with the potential to increase or decrease in worth over time. Their value isn't constant, but they're very relevant to the company's value. Some examples of growth assets are rental property, investments, and equity securities.
These are investment assets that provide the company with protection from investment fluctuations. They're more stable in terms of worth and deliver steady income such as dividends. Some examples of defensive assets include debt securities, savings accounts, and certificates of deposit.
Types of liabilities
There are two primary types of liabilities:
Current liabilities: These are the type of liability that the company pays off and nullifies within one year. They include the company's payments to its vendors and the salary it pays to its employees.
Long-term liabilities: The company pays this type of liability over a longer period. This includes all long-term loans the company takes on and the employee benefits it provides.
Key differences between assets and liabilities
When you compare assets and liabilities you can classify the differences between them into the following categories:
Company worth: Assets typically add value to a company's worth, while liabilities reduce it. Companies generally add up the value of all their assets and subtract their liabilities to determine the value of the business and its financial status.
Credit and debit: A company credits the assets when they decrease and debits them when they increase, while liabilities work in the opposite way. The company credits the liabilities when they increase and debits them when they decrease.
Cash flow: Assets help a company generate cash inflow to settle their business operating costs and pay for emergencies. In contrast, the liabilities cause cash outflow since a company usually has an obligation to pay them to settle accounts.
Depreciation: When it comes to assets, the fixed ones have depreciating value, meaning they slowly lose value due to wear and tear and eventually lose their value when they wear out completely. Liabilities don't depreciate because the company pays for them within a certain period.
Business expansion: A company acquires assets to expand the business and increase its worth. In contrast, it often takes on liabilities to acquire more assets that can eventually pay off the liabilities.
Calculation method: Another difference between assets and liabilities is the method financial analysts use to calculate them. For assets, it's a company's liabilities added to equities, while for liabilities, the company subtracts equities from assets.
What is equity?
After determining total company assets and worth, you can deduct its total liabilities to find its equity. Financial analysts or professional accountants use this approach to determine the company's value after it's paid all debts. In a small company, the equity affects either the owner or a small group of managing partners who handle and cover the business costs. Here, financial analysts typically call this type of equity owner's equity.
Bigger companies are usually accountable to the investors who use their money to provide funds for business operations and generate profits. In this case, financial analysts refer to the equity as shareholders' equity. The two types of equity can help you account for how much the owners or shareholders invested in a company and the retained earnings the company makes due to their revenue and profits.
How to determine equity
Here is the formula you can use to determine equity:
Assets − Liabilities = Equity
Here are the three simple steps you can use to determine the amount of equity a business has:
Determine the company's assets. The first step is to calculate the company's total assets and their value by adding up the total of everything that provides income and contributes to its profit. These items also include all the valuable items the company owns.
Determine the company's liabilities: After determining the company's total assets, the next thing is to determine the total of all its liabilities. These liabilities include all property mortgages, employee salaries, and rents due.
Determine the total equity: You can determine the company's total equity by subtracting the total liabilities from the company's assets. The figure left represents the equity.
Case study example of assets vs. liabilities
Here's a fictional example to explain assets, liabilities, and their differences to help you understand better:
Maria starts a logistics business, Prime Logistics, that she wants to run from an office rather than from home. She also wants to buy trucks and bikes to expand her operations. She knows she can't afford to pay the rent and other expenses, so she takes out a loan. She pays the rent, purchases some equipment, a truck, and several bikes, and hires a few employees for the office. At this point, her assets are the equipment, truck, and bikes, while her company's liabilities are the business loan, its interest, the employee wages, and the upcoming rent for the office.
As Prime Logistics grows and its operations and coverage expand, Maria starts paying off the loan and interest, slowly reducing these liabilities. She also takes some of the company's profits and invests them in stocks, bonds, and equities. Over time, these investments increase in value, meaning the company has more assets. As the business grows, Maria eventually takes on more bikes and more employees, which means more employee wages and more liabilities. Eventually, Maria pays off the entire business loan and interest, freeing the company from that liability and allowing her to focus on growing the company and its assets.
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