Assets are an essential part of the operation of a business because they generate value. They’re the engine that fuels all business activity. Without assets, a business isn’t a business. It might be a dream, an idea, or even a passion project—but it’s not a business.
So let’s take a closer look at what assets are, what they’re used for, and how you report them on a balance sheet. (We’ll get to what a balance sheet is, too, don’t worry.)
What is an asset?
An asset is a resource that a company owns for the purpose of either current or expected future economic benefit. Or, in plain language, an asset is something you own or control that you think can be converted into cash in the future or right now.
Every business has assets. For example, a real estate developer’s assets include buildings and might include other financial assets, like stocks and commodities. A freelance writer’s assets would likely include a computer, keyboard, mouse, and their intellectual property. A home day care operator’s assets probably include their living space, toys, and a playground.
How assets are classified
Assets are classified into three main classes: convertibility, usage, and physical existence. Proper classification of business assets on a balance sheet is essential because your balance sheet is your main hub for demonstrating your company’s financial health. You’ll use it if you’re scouting for investments, securing loans, or even trying to make big managerial decisions. While some assets might appear to fit under more than one class, it’s important to choose one classification that is the best fit for each asset.
Classification based on convertibility
Convertibility—also called “liquidity”—is about how easy it is to turn an asset into cash. Current assets are ones that can be converted to cash quickly, while noncurrent (or fixed) assets are ones you can’t easily and quickly convert into cash.
- Current assets. In order for an asset to be classified as a current asset, it has to be used up or turned into cash (a.k.a. converted) within one fiscal year. Current assets include cash and cash equivalents. Other current assets include marketable securities (like stocks and bonds), accounts receivable (the money your customers owe you), and your inventory, if that’s relevant to your business.
- Noncurrent or fixed assets. Noncurrent or fixed assets are long-term assets that you keep using for more than a year. Examples of noncurrent assets include fixed assets like real estate, heavy equipment, long-term investments, and intellectual property.
Classification based on usage
Assets can also be categorized based on how you use them in your business. Operating assets are ones you use regularly, for the primary purpose of your business. Non-operating assets are ones you own but don’t regularly use or use for secondary purposes of your business.
- Operating assets. Operating assets are ones needed for the primary operation of your business. For example, if you own a bike shop, then the bikes you’re selling would be an operating asset.
- Non-operating assets. Non-operating assets are ones that you’re not using day to day, but that help keep your business financially stable. They might include short-term investments, marketable securities, land you’re not using, or loans receivable.
Classification based on physical existence
Finally, assets can be categorized based on whether or not they physically exist. Tangible assets are ones you can touch with your hand, while intangible assets are ones you own, but can’t touch.
Some intangible and tangible assets are considered “long-lived assets.” Those are ones that are going to bring your company value for longer than a year. Think office buildings, construction equipment, computers, farmland, or long-term stocks.
- Tangible assets. Tangible assets are those you can touch with your hand. They include cash, equipment, property, plants, raw materials, office supplies, and tools.
- Intangible assets. Intangible assets are the things you own that have monetary value, but that don’t have a physical form. Examples of intangible assets may include patents, intellectual property, stocks, and royalties. They also include the value of intangible assets that don’t have an obvious monetary value (like intellectual property, for example). Their value can be calculated either by looking at the value of similar products on the market or by subtracting your company’s liabilities from its assets and then subtracting that number from its market value. The resulting amount is the value of your intangible assets.
Assets on the balance sheet
All of these terms and classifications are important because you need them to create a balance sheet, which is a document that outlines the financial health of your company at a specific moment in time. Balance sheets can be created at any point, but most businesses do an inventory of their accounts periodically, like quarterly or at the end of the fiscal year.
All balance sheets follow the same basic format: assets = liability + owner’s equity. While “assets” refers to the things you own, “liability” refers to the things you owe. Owner’s equity is what’s left if you sell your company, including all of your assets, and pay off all of your liabilities. In simpler terms, it’s the profit you’d make if you sold everything and settled all of your bills.
On a balance sheet, assets are reported on the left-hand side or at the top of the sheet, depending on the format you’re using. Then, liabilities and owners’ equity are listed on the right, or following the assets. Assets are listed in order of how quickly you think you’ll use them up, with current assets at the top and fixed assets at the bottom. Similarly, current liabilities are listed first, followed by long-term liabilities.
The completed balance sheet gives you (and any partners or investors) a clear perspective on the financial health of your business. You can also include information from the previous reporting period if you want to see if things are trending up or down over time.
Getting a clear view of your company’s assets will help you keep things running smoothly, seek investment, and get a bird’s-eye view of the financial health of your business. Understanding your assets at a glance will empower you with the fiscal information to make the best decisions possible.