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Do you find it difficult to formulate your balance sheet? Do you get confused between what are assets and liabilities? Is it that you always tend to classify your assets and liabilities in the wrong manner? Although assets and liabilities seem easy to classify, they can be quite confusing once you actually start recording them in your books of account. This article will help you in classifying your assets and liabilities and so, you will be able to manage your balance sheet in a much more efficient way. Listed below are the differences between assets and liabilities.
Assets are those items which are the property of the company. They can tangible as well as intangible. Tangible assets include those items which can be seen such as plant and machinery, building, land, etc. Intangible assets include goodwill, investments, patents, etc. Assets are what you own and are you receive benefits from these assets at present as well as in the future. For example, when you purchase a building, its benefits are enjoyed in the current financial year as well as in the coming years.
Liabilities are those items for which you are liable to make payments. These liabilities have to be paid to the people you have borrowed money from or taken loans or credit. Usually, a company obtains capital from the general public in the form of shares and from financial institutions in the form of loans. These liabilities are called termed as capital. Other types of liabilities include salary and wages, interest on loans, payments to creditors where goods are taken on a credit basis for a specific period.
Current Assets and Liabilities
Assets which can be converted into cash quickly (usually within one year) are called current assets. They include cash and cash equivalents, accounts receivable, inventory, marketable securities, prepaid expenses, and other liquid assets that can be readily converted to cash. Current assets are important to the business as they can be readily converted into cash for paying ongoing business expenses or day-to-day operations.
Current liabilities are bills which are due and have to be paid within the current financial year. Short- term debts, accounts payable, accrued liabilities, and other debts are examples of current liabilities. The working capital which is the capital required for the day-to-day expense is calculated by deducting current liabilities from current assets (Working Capital = Current Assets – Current Liabilities). A positive working capital indicates that the company is highly efficient and has a good short-term financial health.
Non-Current Assets and Liabilities
An asset whose complete value or benefits will be enjoyed over a period of years is called a non-current asset or fixed asset. Thus, the value of such assets is higher than current assets. Examples of non-current assets include investments, property, plant and equipment, and intangible assets such as goodwill, brand recognition, intellectual property, etc.
Liabilities which are not due within the current accounting year are called long-term liabilities or non-current liabilities. They include long-term borrowing, bonds payable, and long-term lease obligations. Non-current liabilities are important for investors as they want to check whether the company has more capital in the form of debt or borrowing than its owned capital. If the majority of the capital is in the form of debt, then the cost of capital increases as they need to be regularly serviced by interest rates.
You need to classify current assets and liabilities, and non-current assets and liabilities in the right manner in order to get a true and fair view of your financial statements. You may tend to make errors in your financial statements if you do not know what are assets and liabilities and how to classify them. However, if you want to avoid errors in classifying assets and liabilities, it is advisable you consult a professional accountant who will prepare and maintain books of account for your business without any errors.