You were probably introduced to the idea of deposits and withdrawals the moment you opened your first bank account. To save money, you were told, you want to make more deposits and fewer withdrawals—more money in, less money out. The same basic concept applies to running a business.
Whether you like it or not, being a business owner involves accounting. To grasp the state of your finances, it helps to understand what are referred to as assets (money in) and liabilities (money out)—the two primary items on financial statements and balance sheets.
What are assets?
Assets are the items your company owns that either directly or indirectly bring in income or provide a future benefit. Long-term assets are the items you plan to hold onto for more than a year, while short-term assets can be easily converted into cash within a year.
Assets are classified in terms of convertibility, usage, and physical existence:
- Convertibility.Convertibility describes how easily an asset can be liquidated—i.e., converted into cash. Assets are either “current” or “noncurrent” (i.e., “fixed”) assets. Current assets can be converted into cash within one fiscal year, whereas noncurrent or fixed assets can’t. Examples of current assets include cash and cash equivalents, whereas non-current or fixed assets can be real estate, vehicles, and intellectual property.
- Usage.You can classify assets based on how they’re used—either as “operating assets” or “non-operating assets.” Operating assets are those you use in the day-to-day operation of your business, like computer equipment, heavy equipment, or an office building. Non-operating assets, like accounts receivable or investments, keep your business in the black, but you don’t use them daily.
- Physical existence.Assets can be classified as “tangible” or “intangible” based on their physical existence. Tangible assets are those you can touch, like a building or a car, whereas intangible assets are those you can’t touch but still add value to your business, like intellectual property and goodwill.
What are liabilities?
Liabilities are the debts you owe to other parties, including other businesses or the government. Like assets, liabilities can be current or noncurrent. While liabilities seem negative at first, they can be very important for growth. For example, a Small Business Association (SBA) loan is a liability, but can provide much-needed funds for a budding small business owner.
Liabilities fall into two categories:
- Current liabilities.Current liabilities are short-term debts that you plan to pay off within a year, such as credit card balances, payroll taxes, accounts payable, or expenses you haven’t been invoiced for yet.
- Noncurrent liabilities.Noncurrent liabilities are long-term debts that your business must pay off over a longer period. Examples include long-term loans, like a mortgage or a business loan, deferred tax payments, or a long-term lease.
Assets vs. liabilities
You can generally think of assets as money in and liabilities as money out. Assets and liabilities are opposites, though they’re often related because you use a liability to purchase an asset. Say you want to buy accounting software to help you organize your balance sheet, but it costs thousands of dollars. You might take out a small business loan (a liability) to purchase the software (an asset).
Here are more examples to illustrate other possible relationships between assets and liabilities:
- Short-term assets versus short-term liabilities.A short-term asset for an underwear brand might be an order of luxury fabric to make bras, which it plans to use up and sell within a year. The short-term liability would be its credit card balance after it pays for the fabric, which it will pay off by the end of the month.
- Long-term assets versus short-term liabilities. A long-term asset for a milliner who makes high-end custom hats could be a sewing machine, which they can use for many years. Since sewing machines are relatively inexpensive, the payment would only be a short-term liability they could expect to pay off within a year.
- Long-term assets versus long-term liabilities.A long-term asset for a soap company that makes disinfectant devices for phones and tablets might be the factory where it produces the devices, which it plans to use for many years. The long-term liability would be the loans taken out to purchase the building and outfit it to their needs.
Assets, liabilities, and equity on a balance sheet
Think of assets and liabilities as two sides of the same coin—or, in accounting terms, two sides of the same balance sheet. A balance sheet is a financial document that gives a snapshot of your company’s financial health at a given moment. The point of a balance sheet is to map out the relationship between assets and liabilities—that’s what you’re trying to “balance”—to obtain a clear picture of your company’s net worth.
You usually find assets on the left-hand side of your business’s balance sheet and liabilities, along with shareholders’ equity (i.e., how much of your company shareholders own), on the right-hand side of your balance sheet.
The basic accounting equation for a balance sheet is:
Assets = Liabilities + Shareholders’ Equity
Assets and liabilities FAQ
What are examples of assets?
Assets are the items your company owns, including cash and cash equivalents, real estate, vehicles, computer equipment, heavy equipment, office buildings, intellectual property, and goodwill.
What are examples of liabilities?
Liabilities are the debts you owe to other parties. A liability can be a loan, credit card balances, payroll taxes, accounts payable, expenses you haven’t been invoiced for yet, long-term loans (like a mortgage or a business loan), deferred tax payments, or a long-term lease.
What are the types of assets?
Assets are classified in terms of convertibility, usage, and physical existence. Assets can be either current or non-current (convertibility), operating or non-operating (usage), and tangible or intangible (physical existence).