Assets, liabilities, and equity are three core concepts of financial accounting which means that any investor should understand them. It's not that hard to understand what assets are in principle, but, when it comes to practice, things start to get tricky.
In this article, we'll explain the essence of assets in accounting and finance, mention various assets classifications, and give a few simple examples of various assets.
Table of Contents
What are Assets?
An asset is anything of value that a company or an individual owns. This is a basic and simplified definition but it's generally correct. If a company owns $125,000 worth of equipment, that's one of its assets, as well as any property, cash, corporate vehicles, etc. Assets of a public company can be found in the balance sheet section of its annual report.
To calculate the value of company's assets, given its liabilities and owner's equity, use the following formula:
$$ A = L + E $$
- A: Assets
- L: Liabilities
- E: Owner's Equity
Liabilities are the opposite of assets, it's everything a company owes to somebody (customers, other companies, government, etc.), and the difference between company's assets and liabilities is called equity.
Owner's equity, or just equity, is everything that would be left from assets if we subtract liabilities. For instance, if a firm has $3,000,000 worth of assets and $2,000,000 worth of liabilities, its owner's equity would be equal to $1,000,000. In other words, the owner's equity is what would be left of the company's assets if it paid off all of its debts.
Assets Classifications: Physical Existence
A common way to classify assets is based on existence in a physical form, they can be:
- Tangible (physical)
- Intangible (virtual)
Tangible assets exist in the real world in a physical form:
- Office supplies
- Cash, stock and marketable securities
Intangible assets don't physically exist, yet they have value:
- Trade secrets
- Intellectual property
Assets Classifications: Liquidity
Assets are usually listed in the balance sheet based on their liquidity:
- Current assets
- Fixed or non-current assets
Another way to call these two groups is short-term and long-term assets.
Current assets are:
- Cash and cash equivalents
- Short-term deposits
- Stocks and marketable securities
- Office supplies
Fixed or non-current assets are:
- PPE (property, plant and equipment)
Assets Classifications: Usage
Assets can be split into two groups according to the way they're used:
- Operating assets
- Non-operating assets
Operating assets include:
Operating assets are used in day-to-day business operations and they're essential for generating revenue.
Non-operating assets are:
- Short-term investments
- Marketable securities
- Vacant land
- Interest income from fixed deposits
Non-operating assets are still important, but they're usually less relevant to the company's income.
Various kinds of investments (stocks, bonds, etc.) are assets too and they can be divided into two groups:
- Short-term investments (current assets)
- Long-term investments (often a separate category in the balance sheet)
A long-term investment is an investment that a company expects to hold for a long time, let's say more than five years, and a short-term investment may be held for one year or less. Short-term investments are usually more liquid and they can be bought and sold frequently.
An example of a long-term investment would be an aggressive hedge fund that, despite being risky in the short run, can benefit its owners in the long run due to it's high expected return. A short-term investment can be a bond or any other liquid marketable security that can be sold easily.
List of Assets
Here is an example of assets that are commonly present in a balance sheet:
- Short-term investments
- Accounts receivable
- Allowance for doubtful accounts
- Accrued revenues / receivables
- Prepaid expenses
- Long-term investments
- Furniture and fixtures
- Accumulated depreciation
Some companies may not have one or more assets from this list and others could have some assets that are not listed here. Also, the same asset can be named differently depending on the company's policies, practices, and jurisdiction.
Basically, an asset is anything of value that a company possesses. If a company has money, that's an asset too. If a company owns a property worth $1,000,000, this adds up to the total of the company's assets as well.
One common and wrong way to explain what an asset is can be found in Robert Kiyosaki's books. He defines assets as something that generates revenue or has the potential to do so, which is a loose but interesting way to look at it. After all, liabilities usually cause troubles and lead to losses, but in reality, not all assets generate revenue. For instance, marketable security that a company owns can go down in value, but would still be an asset, just a less valuable one.
Assets such as cash or land are easy to understand but things like “accounts receivable” can raise some questions. Accounts receivable cause a lot of confusion because this isn't something that a company actually owns at the moment, but those are payments (invoices, checks, etc.) that are expected to be paid. To understand what accounts receivable are, imagine that a customer just received a service at a company and he owes $100 which he has to pay within the next 20 days. During this period of time, the firm has to record the transaction anyway, even though the money isn't actually on the company's account yet, so it's recorded as accounts receivable. At the moment when the customer pays for the service, a company should subtract $100 from accounts receivable and add the same amount to its cash accounts so the balance won't change.
Other types of assets are usually not hard to understand, but some of them might be strange when it comes to the way they're valued.
Valuation of Assets
Asset valuation is a complex process that we can't address fully in this article, but we'll cover a few important points. Things like cash aren't hard to evaluate. 500 American dollars are equal to 500 American dollars and foreign currencies can be easily evaluated in U.S. dollars based on the current exchange rates. Any liquid marketable securities also have a known value (although it fluctuates).
➤ Read also: What Does Market Capitalization Mean?
But what about things that can't be easily converted to cash?
For example, how can we measure the current value of a company's property? We can truly know this only at the moment of its liquidation (selling). Well, that's why an IPO is a very complicated and expensive process during which all of the company's assets should be evaluated properly by a trusted third party. A common way to record value of certain assets is to do so at the moment when they were properly evaluated, i.e. at the moment of the purchase or at the moment when an appropriate third party completes such a job on behalf of a company. In some cases, assets that have a known market value could have a different book value in the company's balance sheet.
Virtual (non-tangible) things like the company's goodwill complicate everything even more.
A total value of a small firm, especially if it operates in a relatively simple sector like retail, can be properly evaluated easily and fairly, but when it comes to the mid-size or huge multinational corporations, the process of asset evaluation can be extremely difficult.
To see what assets are and how they're recorded let's take a real annual report of a famous company and look at its balance sheet. Let's take Apple company and its Form 10-K annual report for 2019 that can be found here. It will be interesting to look at because a few months ago we wrote an article about Apple stock price with some related analysis.
Let's go to the “Financial Statements” (item 8) in this 101-page document and then to the “Consolidated Balance Sheets” on page 34. Here are all of the assets that belonged to Apple as of September 2019 (in millions U.S. dollars):
So, what do we see here and what should we look at?
Total assets are equal to 338,516, and down below we can see that liabilities totaling 248,028, and the net owner's (shareholders’) equity has to be a difference between them, i.e. 90,488. What does this data tell us?
Assets itself are not that helpful as we don't have anything to compare these numbers to. We need to know the total liabilities as well. Plus, in the report, the same data is mentioned for the previous year, which gives a lot of useful information about money dynamics, the company's strategy, and the overall trends. We aren't going to analyze company's financial health in this article, let's just look at the assets to see if there is something interesting and how the real financial data differs from what accounting and finance students learn in their schools.
As you can see, assets are divided into current and non-current, i.e. by the liquidity, ergo other classifications that we mentioned above are not that wildly used, especially in the U.S. and in the standard 10-K report.
You can see that marketable securities are present in both current and non-current sections, which means that some of them are quite liquid, and others aren't. If you want to dig deeper, proceed to page 41 where the structure of the marketable securities is. You can see that Apple has $85 billion of corporate debt securities and $30 billions of U.S. Treasury securities. To our point of proper evaluation, you can see that those marketable securities have “adjusted cost” and also “fair value”. Then they are divided into short-term and long-term securities.
Accounts receivable and inventories are relatively easy to understand, but what are vendor non-trade receivables? This is basically everything that is not included in accounts receivable, for example; wage advances, tax refunds, or insurance claims that the company expects to receive from its employees, government institutions or other entities. You can find Apple's clarification about it on page 46:
“The Company has non-trade receivables from certain of its manufacturing vendors resulting from the sale of components to these vendors who manufacture sub-assemblies or assemble final products for the Company”
Any proper financial report provides additional details about each entry that can clarify possible confusion, so it's useful to read a few real annual reports to learn more about assets, liabilities, and accounting in general.
These are all the assets that Apple has, there are only 9 groups of them.
In the past, annual reports were much more complicated, but these days it seems that many companies try to simplify their financial reports and present them in a clear manner, which is good for investors and shareholders. However, some particular details about each entry could still be tricky, and many other companies tend to report a more complex asset structure.
Quick Asset Analysis
To evaluate the relations between the company's assets and other important metrics you can use a number of simple indicators that are provided for any publicly traded company. Those include: the current ratio, the quick ratio, return on assets, etc.
Assets in Personal Finance
Assets are usually understood as something that a business or a company has, but assets can also belong to an individual. The same way as a firm owns cash and marketable securities of various kinds, a person can do the same. A person's house is an asset, as well as cars, cash, shares, bonds and everything of a value that a person may own so you can evaluate your own assets in the same way as many companies do.