There are two main components when it comes into the game of money and having a sustainable financial status. Asset and liabilities are the two terms that you need to know and having the knowledge of the differences between the two can help you properly plan how and where you spend your money.
What is an Asset?
In a layman term, an asset can be defined as something that puts money into your pocket or bank account. It can be a piece of machinery that you lease out and get some payment on a regular basis, property that you rent out and collect monthly rent, ownership stake in a company through acquisition of shares that pays quarterly dividends, royalty that you get from your work (for example, music, movie, or book deal). Examples include land, building, equipment, and machinery. You make money on your asset. In another term, an asset is something that you own.
What is a Liability?
Liability, on the other hand, can be defined as something that takes money from your pocket. Liabilities cost you money. For example, if you buy a car on loan and paying monthly interest on the loan, then your vehicle should be considered a liability because it takes money away from your pocket. If you like accumulating material things, clothes, shoes, pieces of jewelry, and so on, you are putting your money into liabilities because you do not earn anything from these items. Liabilities also include credit card debts, mortgage loan, and every other thing that cost you monthly payment to keep. In another term, liability is something that you owe.
What is the difference between assets and liabilities?
One of the significant differences between assets and liabilities is that assets provide current and future economic benefits to you, while liabilities present past and future obligation that you must fulfill. To tell you how important these two terms are, businesses all over the world per regulations always have to include information about their assets and liabilities when filing their financial statements. Successful and thriving firms often have a high proportion of assets to liabilities.
Most people view their homes as an asset, and they will not be wrong if they actually sell it and cash out money. For most people especially in the United States, even if you do have paid off your house, you still need to pay taxes, insurance, you spend money on maintenance of the house, and most of the time, homeowners’ association fees.
- Tangible assets: are those which can be seen or touched by the human eye. You will find tangible assets under plant, equipment or property categories in the balance sheet of a company.
- Intangible assets: are those which can’t be touched and are non-physical in nature. They include features such as brand-names, domain names, software or even computer databases. These assets are believed to bring in more company value than the tangible which are subject to depreciation.
- Current assets: are the items a company owns and consume or are converted to cash within a year. Examples of such include cash, bank balance, inventory, accounts receivable, prepaid expenses.
- Fixed assets: are that which a business owns but will be used by the company for a minimum of a year without conversion into cash. Good examples of fixed assets are land, buildings, fixtures, Furniture and Fittings, Computer systems, Land and Building, Motor vehicle, Goodwill copyright, patent right, etc.
Liabilities can be classified into
Current Versus Long-Term Liabilities
Businesses sort their liabilities into two categories: current and long-term.
- Current liabilities are debts payable within one year; they are short-term loans and bank overdrafts.
- Long-term liabilities are debts payable over a more extended period. For example, if a business takes out a mortgage payable over 15 years, that is a long-term liability. However, the mortgage payments that are due during the current year are considered the current portion of long-term debt and are recorded in the short-term liabilities section of the balance sheet.
To be financially fit and stable, you need to understand these terms and focus on investing in assets and reduce your liabilities. When you invest regularly on income producing assets, after many years of persistence focus, you will be able to start generating passive income that will help you to retire rich. Check out my post about how to become a richer you by building your passive income portfolio.
To win with your money, you must understand the differences between assets and liabilities.