Differences Between Assets and Liabilities for Wealth Management

Assets are what a business owns and liabilities are what a business owes.

A successful business has more assets than liabilities. An asset is a tangible or intangible resource owned by a company that provides economic benefits in the future. These benefits include generating cash flow, improving sales tax, or liquefying the item to a cash equivalent. A liability is something that a company owes or has to pay for in the future. It can be in the form of a loan, mortgage, account payables, or accrued expenses. Accrued liabilities generally pose a future financial obligation. The key to making wise financial decisions is to invest more in assets over liabilities. In this article, we will look deeper at the differences between an asset and a liability. Read on to get more insight.

Basic Meaning

The main difference between assets and liabilities is that assets generate income for your business, while liabilities are obligations to repayment. An asset will keep putting money in your pocket for years if used efficiently and well maintained. Assets increase your business’ value, and the value depends on the asset’s scarcity and ability to increase the economic benefit. A liability account becomes a necessity when you need more money to pump into your business. If you want to expand your business or work on a new project, you source for money from another party. You are then obliged to pay it back in the future as agreed with your debtor.

Types

Liabilities are classified into three main categories:

Current liabilities are debts that have to be paid within one year. These include accounts payable, tax liabilities, and short term loans. A non-current liability is a debt due in longer than a year, usually taken to acquire immediate capital for investment into the company. Contingent liability depend on the outcome of a future event. Product warranties and lawsuits fall under that category. On the other hand, assets are either tangible or intangible. Tangible assets are physical resources such as real estate, inventory, equipment, which have a monetary value. Intangible assets have a theorized value and pay off over 5 to 40 years. Examples include copyrights, patents, and trademarks.

Cash Flow

Assets generate cash flow while liabilities take money out of your pocket. Income generation is a significant factor that determines whether your business will thrive. Assets are of value to a company in that you can use them to generate cash or exchange them for products or services. As much as you want to make money, you will always need some capital to kick-start your operations. You may run out of cash and require external assistance from time to time. Liabilities come in to lessen this burden but at a cost.

Depreciation

Another comparison of assets vs liabilities is that assets are depreciable while liabilities aren’t. Depreciation means that the value of the asset reduces over time due to wear and tear. The only assets that don’t depreciate are land, cash, and current assets (prepaid amounts, accounts receivable, and supplies). At the end of every year, you should record accumulated depreciation of assets in your business financial statement. Liabilities don’t generate income, so they are non-depreciable.

Shareholder’s Equity

The more assets a company has, the more the shareholder’s equity. The more liabilities a company has, the less the shareholder’s equity. Shareholder’s equity is the company owner’s residual claim after all the debts have been paid off. In finance, we calculate assets as below:

Likewise, we calculate liabilities as:

Simply put, shareholder’s equity depicts the difference between how much money you’ve invested and how much you withdraw as a shareholder.

Interest Income and Costs

Assets have the potential to generate accrued interest expense. For instance, if you loan money to another company, you both agree beforehand that they will pay it back with interest. On the other hand, with accrued liabilities, you are on the other side of the equation. You are required to pay back a loaned amount with interest, which translates to an interest cost.

Increase and Decrease in Your Account

Generally, when you increase your assets, this is a debit to your account. A decrease in assets would be credited to your account. For instance, if Valentine’s day is around the corner and you stock up on flowers and chocolate, you increased your inventory while reducing your cash. This translates to a credit entry in your general ledger. If you decrease liability, on the other hand, you will count it as a debit to your account, while credits are increased in liability accounts. For instance, when sorting out your tax liabilities, the money you pay will go to accounts payable, so your account decreases.

Balance Sheet

A balance sheet in financial accounting displays a company’s assets, liabilities and shareholder’s equity at any given time. It is a summary of how much shareholders have invested in the company and what the company owes and owns. When it comes to assets vs liabilities on the balance sheet, normally assets are placed first. You will put details of the company’s total assets on the left side of the sheet. You will then place liabilities on the right side of the sheet after calculating your business’s total assets. When studying your balance sheet, you will appreciate that you need both assets and liabilities for your business to thrive. Assets help you generate cash, but you also need liabilities to create financial leverage for your business.

Consult a Financial Expert

Remember that liabilities are not the same as expenses. Both require that you dish out some money to pay debts. However, liabilities are debts owed to another business, while expenses are ongoing charges that you need to pay for your business to run, such as an electricity bill. To get a better understanding of how to balance assets and liabilities in your business, you need to talk to a financial expert.

FAQ

What is the difference between accounts payable and accrued liabilities?

In companies, accounting is also used to receive or pay in accrual, it all depends on the case but this accrual method can be positive or negative. Many people believe that it is the same thing, but there is an important difference. An accrued expense is the expense payable in the future for some good or service, they are usually current liability made on the balance sheet. Accounts payable, on the other hand, are debts that must be paid in the short term, on a specific accounting period, or by the soonest possible. They are generated when a good or service is purchased on credit. 

What are some examples of accrued liabilities?

First of all, there are many situations where accrued liability arises, and many examples can be built up due to events that occur during a normal course of business life. An example of accrued expense is when employee salaries are borrowed at the end of each period in order to receive, another case of accrued expense is with the taxes or documents payable in the future to have interest accrued. Certainly, this also has to do with a tax return, since some taxes may be due and not payable until the next return, for example, the income tax owed to governments.

Do Accrued Liabilities Affect Cash Flow?

In any circumstance, there will always be a positive or negative influence on the cash flow from the accrued liabilities. It all depends on their management and administration. In some instances, expenses may rise and not be enough to cover the expenses, thus affecting the cash flow of the company. Moreover,  It can be said that effective cash flow can be met by an increase in accrued if the expenses have an accrued liability that exceeds the accrued liabilities that have been paid. Otherwise, if a company mishandles one of these operations can severely affect the present net income and future of the company.

What is an accrual journal entry?

We must know that when a company records the operations it executes, its purpose is to create a unique database that can be used to generate the necessary information for all its users, including external users, during their decision-making process. The records that are kept in the journal are usually known as journal entries. In this way, the accrual accounting process gets a complete record of all events, in chronological order and in its own place. In other words, this process of analysis and accounting recording is imperative for the updating of balances. In a company, the accountant must run the journal adjusting entry as these will allow a complete history of all the operations performed during the whole period.

Is deferred revenue a liability?

When it comes to deferred revenue, most of us must learn that it is a transaction where the money received from a transaction, with no goods or services being transferred yet. Therefore, deferred revenue is not known as real income, since it does not affect the net income or loss in equity, so until it occurs, no actual income can be registered. In other words, deferred revenue is a liability account as it refers to the fact that it has not yet been earned, but represents products or services that belong to a client. Moreover, as the products or services are delivered over a period of time, the revenue is verified and recorded in the main income statement.