What Are Assets and Liabilities? In business accounting, assets, including inventory and fixed assets make up the two most significant categories on a business or balance sheet, perhaps one of the most critical financial statements for small businesses. Most business owners will probably agree that their most immediate asset is their own time and money. The balance sheet does provide some useful information about the assets of a business – what it is worth on the open market, or fair market value, and what its debt is compared to its assets. However, assets do not tell you everything about a company, especially its current and future income and assets.
The difference between assets and liabilities is what determines a company’s liquidity. A company with more assets but less liquid capital is likely to have problems raising new capital and will have to obtain credit to fund short-term operations. Likewise, a business that has a large but decreasing inventory of equipment will have a low level of liquidity, even though its overall assets increase. The reason for this is that a business can easily pay its bills with the cash it already has on hand, but by selling some of its assets to raise capital, the owner is reducing its net worth.
As an owner, how do you judge your asset allocation? There are several good ways to evaluate your asset allocation. One is to look at the profit your business is generating. If you see a substantial portion of your sales coming from one area, then your assets are probably concentrated in that area. For example, if most of your sales come from a customer base in the electronics industry, then you might want to minimize your exposure to the oil and gas, utilities, health care, and other industries that don’t produce enough profit to support your inventory-intensive businesses.
Another good method of asset allocation is to allocate fixed assets to determine their relative value. Fixed assets such as inventory, accounts receivable, and capital equipment are expensive to replace, so they should be purchased when they are still valuable. These types of assets generally depreciate in value over time. A company can write off a percentage of its fixed assets to reduce its liability. This reduces the financial value of the firm but also reduces its taxable income. This is a good choice for firms that generate a high portion of their earnings from sales of fixed assets.
One of the biggest mistakes made by financial managers is holding back fixed assets for one year. When managers hold back these types of assets, they can take advantage of the cheap prices of those things like manufactured goods during that one year period. They can take advantage of the low pricing to make an excessive profit. But if those fixed assets were left alone, then the prices of those things would go down, and the firm would not be able to operate at a loss. Instead, it would have to cut costs, or sell those items at a discount, or experience net income declines.
When it comes to liquidating assets for corporate purposes, there are several ways to do it. A firm can sell all or part of its fixed assets and use the money owed on those things as the liquidating value. The other method is to issue notes for the cash owed on the inventory, and use the cash to pay the outstanding inventory balance. Whatever method a manager uses, though, the principal factor that will determine which method is used is the amount of inventory that the firm has, and the extent to which that inventory can be converted into cash.
Other types of assets that are most often liquidated are accounts receivable and inventory. Examples of these types of assets are sales receipts, accrued expenses, Accounts Receivable, and Inventory, to name a few. The accounting principles that are used to determine when these types of assets must be sold are the same ones that are used for determining the fair value of stock and other types of stock options.
It is important for a manager to realize, though, that some types of tangible assets are exempt from being liquidated. Real estate is one such asset, because the real estate itself is not an economic resource. Also, if the value of a stock option is based on the fair market value of a certain equity, then a fundamental analysis of the firm is not necessary, as the value of stock in hand does not have any effect on whether the option will be exercised. However, if an option is used to limit the loss on an existing stock, or to limit the gain on an existing stock, then a fundamental analysis must be done to determine whether the potential gain would offset the loss from exercising the option.