What is Assets and Why Do We Own Them?

Assets are the resources that have economic value for their owners. In this article, we will also be discussing their types.

In this article, we will be discussing what is assets and what is the importance of owing them.

Table of Contents

• What is assets?
• Classification
• Types

What is Assets?

It is a resource of economic value that produces benefits by either generating or decreasing the cash flow. These are the resources that will reap benefits in the future to its owner. They improve sales, reduce expenses and generate gains in the future. To understand what will be classified as an asset, we will take two examples. 

1. Suppose, you buy a machine to produce spare parts to be sold. These spare parts will earn you money in the future. This makes the machine an asset for you. 
2. Suppose you have loaned money to someone at an interest rate. This money will be an asset for you since it will earn you more money in the future.

An asset has the following key properties:

• Have an economic value that makes them exchangeable and sellable. 
• Generate economic benefits in the future.
• Represent ownership that can be converted into cash or cash equivalents.

Classification

These can be classified in the following three ways:

1. Physical existence: This classification is based on whether an asset has a physical form or not. If it has a physical existence, then it is a tangible asset. In case, it does not have a physical form, it is an intangible asset. 
2. Ease of convertibility: These are also classified based on the ease of convertibility into cash. If they get converted in less than one year, they represent current assets. If it takes more than one year, they are fixed.
3. Purpose: They are also classified based on their purpose. If it is used for day-to-day business operation, it is known as an operating asset. If these are not needed on a day-to-day basis are non-operating assets. 

Types of Assets

In the above section, we have discussed what is assets, their classification and properties. In this section, we will discuss their different types.

1. Current Assets

These are the short-term economic assets that are capable of generating returns in one year. These are expected to be sold by next year as a result of standard business operations. They include cash, cash equivalents, stock inventory, accounts receivable, prepaid liabilities, and marketable securities. These are used for funding the day-to-day business operations and for paying the operating expenses. 

Current assets also include liquid assets that can be liquidated within the period of one year. Fast-moving consumer goods (FMCGs) are such liquid assets.

To calculate these, one has to go through the balance sheet. Then, by adding up the following components, one can find out the total current assets:

Cash + Cash Equivalents +  Marketable Securities + Inventory + Accounts Receivable Prepaid Expenses + Other Liquid Assets = Current Assets

​Let us understand each component of the above-given equation.

Cash and Cash Equivalents

Cash and cash equivalents are the line items on a balance sheet that report the value of company assets. These are either cash or have the capability of immediate conversion into cash. Equity and stock holdings are not part of cash equivalents since their value can fluctuate. Treasury bills, commercial papers, short-term government bonds, and debt securities with less than 90 days of maturity period are cash equivalents.

Marketable Securities

These are liquid financial instruments that can be converted into cash. Their maturity is within the period of one year. These may include treasury bills, money market instruments, common stocks, etc. Marketable securities are traded on public stock or bond exchange. All these can be sold through a broker. The return on these securities is less since they are highly liquid. 

Inventory 

These are the produced goods that are available for sale. These come under assets because they can be sold and can earn revenue for the company.

Accounts Receivable (AR)

It refers to the balance of money that the customers need to pay the firm for goods and services used. These are listed on balance sheet as current assets. This is the money due for the short term which makes them a part of current assets. These represent the line of credit extended by the company to its customer. The terms require the payment to be made within a short period of time. 

Prepaid Expenses

Prepaid expenses refer to a type of asset on the balance sheet. This results from when businesses make advance payments for goods and services that will be received in the future.  

2. Fixed Assets

These will give you returns in a longer period of time. This is why they are known as long-term. They will not yield returns within one year but have future benefits. Machinery, plant, software, equipment, and property are some examples. Their value depreciates with their age since these undergo wear and tear with time. 

A fixed asset usually has a fixed form. These are reported as PP&E (Property, Plant, and Equipment) on the balance sheet. These are non-current assets which include intangible and long-term assets. The intangible fixed assets do not have a physical form and are used over the long term. Copyrights, intellectual property, trademarks, and goodwill are intangible in nature. 

They generate revenue in the long term due to which companies expense them differently. If it is tangible, it will be subjected to periodic depreciation. In case, the fixed asset is intangible, it will be subjected to amortization. 

Since the asset’s value decreases with depreciation, corporations can match the cost of the asset with its long-term value. These are important to industries that require huge investments for producing goods and services. For instance, the manufacturing industry has large investments in PP&E. 

3. Tangible Assets

These have a physical form and have a finite monetary value. Tangible assets are the main form of assets in most industries. One can identify them on the balance sheet listed by their liquidity. These are recorded at the cost incurred for acquiring them. Land, equipment, property, and vehicle are tangible in nature. Bonds and stocks are also tangible in nature. 

4. Intangible Assets

Intangible assets do not have a physical form. Trademark, intellectual property, goodwill, and copyrights are intangible in nature. Businesses can create or acquire them. These do not have any recorded book value.

These can be further classified as definite or indefinite. If an asset has a limited life, it is definite in nature. Another company’s patent with legal bound of time is a definite asset. 

An indefinite asset continues to be of use till the company operation continues. These resources will not be amortized but it is tested for impairment on an annual basis. Goodwill and trademarks are indefinite intangible assets.

Conclusion

Assets are important for everyone. These can be personal or business assets with their own importance and value. When used in an efficient manner, they can reap maximum returns over time. In fact, certain assets such as land or bonds can become an essential part of investment while you are thinking of retirement planning.