What is an Asset?
An asset is anything that belongs to a company or to an individual. It can be sold for cash. Typically, assets produce income or provide value to their owners. In financial accounting, assets are economic resources.
On the business side of things, assets are those things that your company owns, from the computer on your desk to the file cabinet in the backroom to the delivery van in the driveway.
It works the same way for your personal assets. The money in your checking account, your clothes, your 60-inch flat-screen TV, and the fork you just used at dinner all count as assets. It does not matter whether your as- sets are big or small. All that matters is that you or your company owns them, and that they have monetary value.
For that matter, assets don’t even have to be physical things. Patents and copyrights, for example, count as assets even though you can’t touch them. Also, anything you or your company has a legal right to get, such as a tax refund or a future payment from a customer, is accounted for as an asset.
Assets seem deceptively easy to understand, but the category comes with some unexpected twists—there’s a lot more to learn here, as you’ll find out a little later.
Right now, we’ll take a more general look at why assets are so important in both your personal life and in business, and how they factor into your total financial picture.
No matter how small your business is, no matter what industry your company is part of, your company has assets. From a computer used to prepare customer invoices to a 20,000-square-foot processing plant, every single thing your company owns is an asset, as long as you can assign a dollar value to it.
Some assets are physical, such as chairs, copy machines, and delivery vans. Others are legally binding promises, such as accounts receivable, which is the money owed to your company by its customers.
Still, others seem to exist more on paper, though they may also have tangible forms, such as the company checking account or prepaid expenses (for example, a year’s worth of insurance paid in advance). Regardless of the form it takes, anything with monetary value that your company owns or owns the rights to (such as the right to collect money from customers who owe it) counts as an asset.
Your company’s assets appear on its balance sheet, which is one of the main financial statements produced at the end of each accounting period. In this report, the assets will be split into different categories to make analysis easier. The order in which you list them on the balance sheet typically matches the way they appear in your chart of accounts (a formal listing of every account and its corresponding account number), which is usually in the order of liquidity (how quickly they can be turned into cash).
Assets do more than just show up on reports, though. They are the resources your company uses to produce revenue, and revenue is what keeps your company alive. Your business cannot bring in sales without assets, and while this connection is more clear for product-based businesses, which could not produce a dime of revenue without inventory to sell to their customers, it’s true for service companies as well.
At the very least, you have to have the cash to pay your expenses, and to help get the word out that your company exists. Service companies also need basic tools to provide service to customers: a hair stylist needs a chair, scissors, and styling tools; an accountant needs a computer and a lot of file cabinets.
You probably don’t think about this very often, but just like in a business, everything you own is your asset. And while this might not seem very important, sometimes it will be. When you apply for a loan, the lender may ask to see a personal balance sheet—and your assets will be the highlight. If you buy homeowner’s or renter’s insurance (which you absolutely should), the insurance company may ask for a list of your assets. So when the occasion arises, it’s important to know what you have.
The big stuff is obvious: house, car, motorcycle, boat, or truck. But other personal items that count as assets may not be as apparent. When you’re taking stock of your assets, make sure to include:
- All of the money in savings and checking accounts (right now)
- Retirement accounts
- Jewelry (including watches)
- Appliances (refrigerator, washer/dryer, microwave)
- Electronics (phones, tablets, TVs, computers, game consoles)
- Home décor
- Fitness and sports equipment
- Tools (power tools, lawnmower, screwdriver set)
- Kitchen items (dishes, cookware, silverware)
Everything of value that you own is your asset. The items that don’t quite fit into the categories listed get lumped into personal property, things like your clothes (unless they’re high-end designer clothes and fur coats), sheets and towels, and kids’ toys. Even if these personal items aren’t individually all that valuable, all together they can add up to thousands of dollars.
Since there are so many different kinds of assets, they get split into categories to make accounting less cumbersome. There are four commonly used groupings, which are pretty standard across businesses:
- Current assets: Current assets include anything that is expected to be turned into cash or used up within one year, such as inventory or cash itself.
- Investments: The investments category contains holdings, such as mutual funds or municipal bonds that are not really used in the normal course of business; they’re a way to make some extra income using funds that the company doesn’t need to use for anything else right now.
- Fixed assets (also called “property, plant, and equipment”): Fixed assets have relatively long lives, and they are regularly used to support regular operations; examples include trucks, desks, and computer systems.
- Intangible assets: Intangible assets are long-term assets that have no physical form but are still worth money to the company, such as a corporate logo or a trademark.
Basically, anything that is expected to be converted to cash within one year of a company’s balance sheet date is considered a current asset; all other assets are plunked down into one of the long-term categories (investments, fixed assets, and intangible assets).
Even within these broad categories, the assets have a particular pecking order.
For example, your current assets have a liquidity pecking order. Cash is already cash, so it always comes first. An asset like prepaid expenses (such as payment of a whole year’s rent in advance), on the other hand, comes with a fixed use-up date, which usually makes it the last current asset listed. Fixed assets have their own ranking system as well, but that organization is based on how long you expect the assets to last, also known as their useful lives. For example, a delivery truck might have a 10-year useful life, while an office building could last for 30 years.
Current assets include anything that could be or that you expect to be converted into cash within a year of the date on your balance sheet. These assets are listed in their order of liquidity, from cash down to the current asset that you expect would take the longest to convert to cash (usually a prepaid expenses account). Here are the most common current assets, in order of liquidity:
- Cash, which includes every cash account plus any cash you have on hand
- Accounts receivable, which is money your customers owe you for sales you made to them
- Inventory, which includes anything you will resell regardless of the form it’s in now
- Short-term investments, such as stocks or bonds that you plan to cash out within a year
- Prepaid expenses, which are expenses paid in advance of use, such as insurance or rent
The more current assets you have on your books, the more liquid your company is. For small businesses and startups especially, liquidity can mean the difference between success and failure.
When your company is doing well and you have extra cash lying around, you may choose to invest that money so it can earn even more. Any investments that you make and plan to hold on to for more than a year fit into the long-term investments category. These investments could include stocks, bonds, ETFs (exchange-traded funds), mutual funds, and even high-yield CDs; they also can include assets such as buildings that you are holding for investment purposes only, rather than using within your core business.
Long-term investments are often used to build asset reserves that can eventually be used to finance expansions, thereby minimizing the amount you would have to obtain from outside sources. Outside capital can be costly: bank loans always come with interest payments, and bringing on investors or business partners dilutes your ownership. Instead of taking the cash as an owner’s withdrawal (or dividend), and hoping to be able to put it back in when it’s needed, many small business owners instead invest that surplus cash, and then sit back and (hopefully) watch it grow.
As your expansion plans get closer, and you think the time is coming to liquidate those investments, you can shift your long-term investments into your short-term investments. Investments you expect to sell within the upcoming year transform into current assets for the company’s balance sheet.
Any physical asset that your company owns and does not intend to sell falls into the fixed-asset category. Fixed assets range in size, useful life, and purpose. A $40 office chair counts as a fixed asset just as much as a 15,000-square-foot storage facility. The point is that they are both part of what the company needs to have in order to produce revenues, and you plan to keep them around for a long time.
Fixed assets can include things such as:
- Building improvements
- Office furniture
- Computer hardware
Fixed assets also come with a special contra account (an account with a normal credit balance that offsets the fixed assets account). This special contra account, called accumulated depreciation, fits in the asset category but has a normal credit balance (which is what makes it a contra account). It holds all of the depreciation expense ever taken on the connected assets.
Depreciation expense tracks the declining value of assets year by year, and lets you take that decline as a tax-deductible expense spread out over the entire life of the asset. For example, if your company buys a brand-new delivery van, it starts losing value as soon as you drive it off the lot. Normal wear and tear occur throughout the year, detracting even more from its original value. Depreciation expense puts a dollar amount on that wear and tear, to reflect the real current value of the van.
Some companies have assets without physical form that they plan to hold on to for the long haul. These are called intangible assets, and some companies couldn’t succeed without them. In order to count an intangible as an asset, your company must own it or have the rights to it, and it has to have a measurable dollar value. Some of the more common intangible assets include patents, copyrights, licensing agreements, trademarks, franchise rights, leaseholds, and goodwill (the most intangible of them all).
Goodwill can be the most confusing of these intangible assets, because it really only exists in perception, and can only be measured when a business is purchased. The goodwill asset essentially represents the reputation of a company—its good name. It only comes into accounting play when someone buys a company for more than it would be worth by the numbers alone.
Like fixed assets, intangible assets have finite useful lives over which they de- cline in value, at least for accounting purposes. This decline is known as amortization, and it counts as a tax-deductible expense. Since the longevity of intangible assets can be hard to pin down, their useful lives are considered to be their legal lives or 40 years, whichever is shorter.
For example, a design patent issued by the U.S. government lasts for 15 years. Amortization can be held in a separate contra account called accumulated amortization, or may simply be deducted directly from the intangible asset balance; the choice is yours (or your accountant’s).
Assets vs. Liabilities: What’s the difference?
Assets should never be confused with liabilities. Assets create positive cash flow, which is value or money that enters the accounts of a business, organization, or individual.
Liabilities are obligations that must be paid and create negative cash flow or drain money from the accounts of a business, person, or organization.
An example of the difference between the two: Assets are houses that are rented out and produce more rental income each month than the expenses, interest, and maintenance of the houses. Liabilities would be homes that have payments due each month and do not provide an income stream to effectively offset that.