A company’s profit and loss are influenced by several factors. Arguably, one of the most important factors is an asset. In simple terms, an asset is defined as a resource that is purchased primarily to increase the company’s value.
Understanding the role of an asset in the business’s performance is vital. We take a closer look at the meaning of assets, their types, and their importance.
What is an asset
An asset is something valuable that a person, business, or country owns, like money, property, investments, or equipment. It is expected to provide future benefits or help make money.An asset’s meaning in the financial world isn’t very different. A company reports and displays its assets on its balance sheet, and these assets are either created or purchased to increase the company's value or benefit its operations.
It is equally important to know what is — or can be considered an asset. You can consider the following parameters to judge if something is an asset.
- It is owned by you
- It is owed to you
- It must be an economic resource that offers current, future, or potential economic benefit
What is considered an asset?
An asset is anything that provides a current or potential future monetary benefit to whoever possesses controls over that asset. In easy words, an asset is something economically valuable that you own or that is owed to you. If you lend money to someone, that loan is also an asset because you are due that amount. For the person who owes the money, the loan is a liability.
Example of asset
Let us understand the meaning of an asset through an example. Let us assume Mr. X gave Mr. Y a certain amount as a loan, and Mr. Y agreed to repay the amount with interest after a certain period. This loan amount can be considered an asset to Mr. X, as it offers a future economic benefit in the form of interest. Concurrently, the loan amount becomes a liability to Mr. Y, as he has to repay the amount with interest. This example also highlights the key difference between assets and liabilities.
Besides physical assets, you will also encounter intangible (or non-physical) assets, which are quite similar to physical assets in terms of functionality. Intangible assets also offer economic benefits, but they do not exist in a physical form. A few examples of non-physical assets are patents and trademarks (IPs), royalties, financial assets like shares of stocks, and contractual obligations.
Assets vs. Liabilities
Assets are what a company owns, while liabilities are what it owes. Assets increase a company's value, while liabilities decrease it. A financially healthy company has significantly more assets than liabilities. If the opposite is true, the company could be in financial trouble or even on the brink of bankruptcy.
Types of assets
Assets can be broadly categorised into four types:
- Current or short-term assets
- Fixed assets
- Financial assets/investments
- Non-physical or intangible assets
Short-term assets
Short-term assets, also called current assets, are short-term or temporary economic resources that are earmarked to be converted into cash within a year. Examples of short-term assets include cash or cash equivalents, inventory, and prepaid expenses. These are crucial for day-to-day operations, and accountants must periodically assess the recoverability of inventory and accounts receivable.
Fixed assets
Fixed assets, also called non-current assets, include long-term resources like property and machinery. These signify long-term investment, and factors like periodic charges and depreciation are taken into consideration while making adjustments for ageing of these assets.
Financial assets or investments
These assets represent investments in the properties and shares of other institutions. Such assets include corporate and sovereign bonds and hybrid securities.
Non-physical or intangible assets
Intangible assets, also called non-physical assets, do not have a physical value. Examples of non-physical assets include patents, copyrights, trademarks, contracts, and royalties. Depending on the type of asset, the accounting for these assets can vary. Intangible assets are typically amortised or tested for impairment annually.
Each asset type mentioned above holds individual importance and distinct implications for the company’s operational efficiency and strategic direction.
Three Key Properties of Assets
For an item to be considered an asset, it must meet three criteria:
- Ownership or control: The company must own or have the right to use the item.
- Economic value: The item must be convertible to cash or can be used to generate revenue.
- Future benefits: The item must have the potential to provide future financial advantages.
Conclusion
It is vital to understand an asset’s meaning, as it is more than just an entry on a balance sheet. Assets are the foundation of a business’s operational and financial strength. Strategic asset management and precise valuation are essential for the company’s sustainability and growth. While assets come in different types, they are used for one common purpose — obtaining current, future, or potential economic benefits by companies, individuals, and firms.
