Did you know that America's top 100
companies had a combined market capitalization of more than $12 trillion in the year 2019?
Managing such levels of wealth
requires detailed accounts management and bookkeeping. The balance sheet is
among the essential accounting tools every business, whether big or small,
needs to make this happen.
A typical balance sheet comprises
two primary categories. These are the assets and liabilities. To successfully
manage your balance sheet, you need to conceptualize asset vs liability and
know the difference.
What does your balance sheet say
about the health of your business? Until you understand the difference between
asset vs liability, it may be hard to interpret your business' accounts. Here,
we breakdown the key similarities and differences between assets and
liabilities.
What
Are Assets?
The best way to understand the
difference between an asset vs liability is to define each of these items. An
asset is anything that a business owns. Assets often add value to your business
through direct or indirect inflow.
When assessing the differences
between assets and liabilities, your focus should be on value addition and
value reduction. Assets often increase your business' equity. Here, the Harvard Grace Corporation demystifies the general
understanding of assets further for you.
What
Are Liabilities?
A liability is anything in your
business or balance sheet that decreases your company's value. When you
categorize an item or an entry on your balance sheet as a liability, it means
that your business owes another entity or should pay another business the value
of such liability.
Asset
vs Liability: Similarities
When assessing assets and
liabilities, there're often more differences than similarities. The main
similarity between the two items is that both appear on the company's balance
sheet. On the same note, both assets and liabilities fall into either current
or non-current items on a balance sheet.
Both assets and liabilities have
balances, which are useful when balancing the business' accounts at the end of
each accounting period. Further, investors are often concerned with both assets
and liabilities when valuing your business. These are the main similarities
between assets and liabilities.
Differences
Between Assets vs. Liabilities
When preparing your balance sheet,
you'll tend to notice obvious differences between an asset vs liability.
Inherent
Meaning
The main difference between assets
and liabilities is the inherent meaning. An asset refers to the current and
future benefits receivable to your company. In contrast, a liability is any
obligation your entity owes to other businesses.
The difference in the inherent
meaning forms the basis on which accountants list assets vis-à-vis liabilities.
When preparing your balance sheet, the difference between the total assets and
the total liabilities defines your actual profits for the period.
Depreciation
Depreciation refers to a reduction
in the value of assets over time. This occurrence may be
due to wear and tear. When preparing a company's balance sheet, there's often a
provision for depreciation. The other difference between assets and liabilities
is that assets are depreciable while liabilities are non-depreciable.
The balance sheet only has a
provision for depreciation for assets. If you are assessing your business's
health, depreciation stands out as an expense after preparing the balance
sheet.
Categorization
The other difference between assets
and liabilities on a balance sheet is the categorization. While both assets and
liabilities fall broadly into current and non-current categories, assets fall
further into specific sub-categories.
Assets either fall into tangible and
intangible assets, current and non-current assets, or fictitious assets. The
subsections are critical when balancing off your balance sheet. Liabilities, on
the other hand, only fall into current and long-term liabilities.
Balance
Sheet Format
When preparing your balance sheet,
the format is critical for ensuring that you balance off the accounts. Assets
should appear on the right side of the balance sheet, considering that they
increase your accounts. It's important to identify all the assets and place
them, as they should appear on the balance sheet's right side.
On the other hand, all the
liabilities should appear on the balance sheet's left-hand side. This ensures
that you have all the items that reduce your accounts on the balance sheet's
left side. In case you confuse any of these entries, you might end up
struggling to balance off the balance sheet.
Calculations
Are you trying to understand the
difference between assets and liabilities? It's important to understand how to
calculate the value of each item. When calculating assets, you need to subtract
the owners' equity from the total liabilities.
To get the value of liabilities, you
need to subtract the owners' equity from the total assets. Any person trying to
find your company's net value will consider these two formulas. The owner's
equity often says a lot about your debt.
The
Composition of Assets vs. Liabilities
The makeup of a balance sheet and
your ability to balance your accounts depends on your understanding of what
makes up the assets and liabilities in a balance sheet. The most common
examples of assets items that should appear on your right side include:
- Liquid Cash
- Investments
- Inventory
- Office equipment
- Machinery
- Real estate
- vehicles
When considering liabilities, you
need to be careful to include all the items that make the left-hand side.
Examples of liabilities on a balance sheet include:
- Bank debt
- Mortgage debt
- Money owed to suppliers
(accounts payable)
- Wages owed
- Taxes owed
It's important to understand where
each item fits when preparing your balance sheet. One of the best ways to
differentiate between assets and liabilities is to understand where each item
falls on the balance sheet.
This
Is How to Differentiate Asset vs Liability
When assessing your business
accounts, it's critical to differentiate between assets and liabilities. Some
of the main things you look for when assessing your company's performance
include liquidity and equity. The only way to calculate these items the right
way is to know the difference between asset vs liability.
With these similarities and
differences listed in this article, you can now assess your business' accounts
with incredible ease. Now, you can interpret how your balance sheet looks like.
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