Assets vs. liabilities - what’s the difference?

Understanding the difference between assets and liabilities will empower you to make the right decisions when managing your business finances.

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Without this knowledge, you won't be able to make informed decisions about taking on debt, purchasing inventory, or keeping track of customer payments.

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Keep reading to learn more about these two critical items on your balance sheet.

What's the difference between assets and liabilities?

Assets are resources that you own and help you make money, and can come in tangible or intangible forms. They add value to your company and help you settle the debts you owe, which are referred to as liabilities. These can come in the form of financial payments, goods to be delivered, or services to be rendered.

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Assets represent future economic benefits, while liabilities represent future obligations. They both can be found on the balance sheet and are key indicators of a company's financial profile.

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Assets and liabilities can come in many forms. For example, cash, inventory, and property can all be considered assets. Liabilities, on the other hand, include things like loans, credit card debt, or accounts payable.

What is an asset?

Assets are defined as something that an individual or company owns, with the expectation that it will provide future economic benefit. Assets are listed in the upper half of a balance sheet.

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Not only do assets represent current economic value, but they also represent the opportunity to generate revenue. For example, a building might be an asset that can generate future income through rentals. A loan can also be an asset because it is something owed to you that will presumably be paid back in the future.

Here are some common examples of assets:

• Cash
• Inventory
• Fixtures and furniture
• Machinery and equipment
• Property
• Intangible assets like trademarks, patents, and copyrights
• Prepaid expenses
• Accounts receivable

Four types of assets on your balance sheet

There are two main categories of assets: current and long-term. Some assets can be further categorized as financial assets or tangible and intangible assets.

Current assets

Current assets are short-term assets that are expected to be consumed or converted to cash within a year. They include:

• Cash
• Accounts receivable
• Inventory

Generally speaking, a company with a significant amount of current assets has a strong financial profile. That's because it has enough working capital to spend on expenses without taking on debt.

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Sometimes, current assets in the form of inventory or accounts receivable may be written off as impaired if the company cannot recover these costs.

Long-term assets

Long-term assets are typically fixed assets that are held for more than a year. These include, but are not limited to, things like:

• Buildings and land
• Furniture
• Equipment
• Vehicles
• Loans that won't be repaid for several years

Since many of these assets will depreciate in value over time, accountants will adjust their value over time. However, some fixed assets, such as a desirable piece of real estate, may increase in value.

Financial assets

Financial assets represent value in the form of investments made in the assets of other institutions. These can be more challenging to account for, as their value may fluctuate regularly. Financial assets include:

• Stocks
• Bonds
• Preferred equity
• Hybrid securities

Intangible assets

Unlike fixed assets such as equipment or property, intangible assets are not physical objects. Instead, they are resources with a financial value that may only exist on paper and in contracts. Examples include:

• Copyrights
• Patents
• Trademarks
• Customer databases

What is a liability?

A liability is an obligation or something that is owed to another person or entity. Some liabilities are tangible, such as credit card debt, while others may not currently exist but may exist in the future, such as a potential lawsuit.

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Not all liabilities are considered negative. Often, they are included in business plans, such as when a business obtains a loan to expand its operations.

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Liabilities are typically found in the bottom half of a balance sheet. Here are some examples of common liabilities:

• Mortgages and leases
• Credit card debt
• Loans or lines of credit
• Tax liabilities
• Accrued expenses such as interest, taxes, wages, or utilities
• Deferred tax liabilities
• Unearned revenue

Two types of liabilities

Like assets, liabilities are divided into two categories: current liabilities and long-term liabilities. However, a liability can also be accounted for in both balance sheet sections

For example, a 30-year mortgage is considered a long-term liability, but the portion of its debt owed within the current financial period is also counted as a current liability.

Current liabilities

Current liabilities are short-term debts that must be paid back within one year or a standard operating cycle.

An operating or cash conversion cycle is defined as the time it takes to buy inventory and turn it into cash via sales.

Here are some examples of current liabilities:

• Accounts payable: the amount owed to suppliers for goods or services received but not yet paid for
• Wages payable: accrued income earned by employees that hasn't yet been paid out
• Interest payable: on long-term loans or purchases made on credit
• Dividends payable: owed to shareholders based on issued stocks
• Notes payable: principal of outstanding debt
• Short-term debt: bank loans or other funding sources
• Unearned revenue: based on advance payments for goods and services not yet delivered
• Income taxes: owed within the next year

Long-term liabilities

Long-term liabilities follow current liabilities on the balance sheet. They typically include liabilities with a due date later than one year but can also include liabilities due within a year if the company's operating cycle is shorter.

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Another exception to the year limit is in the case of refinancing current liabilities. If a company shows evidence that refinancing has already started, it can report current liabilities as long-term liabilities with obligations due later than 12 months.

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The most common type of long-term liability is bonds payable, which is a form of long-term debt. For instance, if a company issues bonds to support its ongoing operations, they act as loans from the purchasing parties. Bonds payable are constantly adjusted as they are issued, reach maturity, or are called back.

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Other examples of long-term liabilities include:

• Deferred taxes: typically extending to tax years a year or more in the future
• Mortgages: as long as they are not due within the next 12 months
• Loans: for things like machinery, equipment, vehicles, or land
• Debentures: debt that isn't secured by physical assets or collateral
• Pension obligations: due to employees or their family members post-retirement
• Warranty liability: estimated time and money spent repairing products agreed upon in a warranty
• Contingent liability: liabilities incurred by unpredictable future events

Accounting for assets vs. liabilities

Assets and liabilities are calculated in reference to each other to understand equity, which is what a company is worth financially.

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Here’s the formula:

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Assets - Liabilities = Equity

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Having more equity (specifically, book value equity) on the balance sheet means that your company has more current and long-term resources (assets) than current and future debt (liabilities). If your equity comes out as a negative number, it means your company is not financially sound. The technical term for this is insolvency.

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To account for assets and liabilities, first, find the total of your cash, resources that can be converted to cash, and everything your business owns. Don’t forget to add intangible assets like intellectual property as well.

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Then, calculate all of your business’s current and future financial obligations. These are your liabilities. To find your company’s total net worth, subtract your liabilities from your assets.

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Assets and liabilities come in many forms, from cash and inventory to loans and accounts payable, so it’s important to keep track of both balance sheet items to understand your company’s financial profile. These days, it’s easier than ever to keep your accounting up to date with advanced software that saves you time and effort by automating tedious bookkeeping tasks.

Get more control of your bookkeeping with Ramp

By using a solution like Ramp, you can go far beyond simple bookkeeping and gain insights that help you reduce costs and uncover new opportunities. Through smart accounting automation software tools powered by AI, you can learn how to better allocate your resources to generate revenue and reduce debt.

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Want to learn more about how you can take control of your bookkeeping with Ramp? Get started here.