Most of us have heard the term asset used in business, but not everyone knows what it means or how it differs from its cousin, liability. When you’re starting a new business or trying to decide if your startup has staying power, understanding assets and liabilities is crucial to calculating your company’s long-term value. What are assets and liabilities? Assets are things that bring you income or that are worth money in the future.
People often think of their assets and liabilities regarding their financial worth. However, these two concepts can be applied to any area of life. For example, when considering a job offer, you might weigh the assets – such as the potential for growth, the commute, and the company’s culture – against the liabilities – such as the salary and hours.
- In personal relationships, we often think about how our assets – like our sense of humor or our ability to cook – balance out our liabilities – like our tendency to snore or get angry quickly.
- Regarding our health, we might consider exercise and diet assets, while smoking and a poor diet could be seen as liabilities.
- While it’s essential to be aware of our assets and liabilities in all areas of life, it’s especially crucial when making big decisions.
What Are Assets?
An asset is anything that puts money in your pocket. In other words, it’s something that can generate income or appreciation. That could be a rental property, a stock portfolio, or a business. If you were to sell your house tomorrow for $500,000 and had bought it five years ago for $400,000, then you have an increase of $100,000 on an asset! Liabilities: A liability is basically what drains money from your pocket.
What Are Liabilities?
A liability is anything that a company or individual owes. This can include money, goods, or services. Liabilities are usually either short-term or long-term. Short-term liabilities are debts that need to be paid within a year, while long-term liabilities are debts that will take longer than a year to pay off. Assets, on the other hand, are anything a company or individual owns. This can include cash, investments, property, and inventory.
Difference Between Assets and Liabilities
An asset is anything that increases the value of something else. An example would be if I had $100,000 cash sitting around, then that would be my asset. If I were to invest that money somewhere else, then that investment would become my asset.
A liability is anything that decreases the value of something else or costs someone money. An excellent example of a liability is if I owed someone $100,000, then that would be their liability. If they lent me $100,000, and I never paid them back, then that loan would be their liability.
Simply put, your assets are what you own, and your liabilities are what you owe. Your assets can be used to pay off your liabilities. Anything that is left over is considered equity. Some people call this net worth or net value. Assets minus liabilities equals equity, which means if you have $1 million in assets but $2 million in liabilities, then your equity would be $1 million.
Why Knowing the Difference Matters
Regarding your finances, it’s essential to know the difference between your assets and liabilities. Your assets put money in your pocket, while your liabilities take money out of your pocket. To build wealth, you need to focus on increasing your assets and decreasing your liabilities.
To do this, ensure you save a portion of your monthly income and pay off any high-interest debt before investing. If you’re struggling with managing your finances and can’t seem to get ahead financially, talk with a financial advisor about how they can help!
Cars: Assets vs. Liabilities
Cars are a common asset that people own. They can be used for transportation, but they can also be sold for a profit. Liabilities, on the other hand, are expenses that must be paid. For example, if you have a car loan, the car is an asset, but the loan is a liability.
If you have a credit card with $5,000 in debt on it, your credit card balance is a liability because it must be paid off. On the other hand, the cash in your bank account would be considered an asset because it could be used to buy something or make more money.
Cell Phones: Assets vs. Liabilities
Let’s say you buy a new cell phone for $1,000. You now have an asset. But, if you don’t have the money to pay for it upfront, you have a liability. Your asset is your phone, but your liability is the $1,000 you owe. When it comes to personal finance, it’s essential to understand the difference between assets and liabilities to make smart decisions with your money. For example, let’s say you get a low-interest loan from your bank to buy a car.
That car becomes an asset because it increases in value while also providing transportation. The money that you borrowed from the bank becomes a liability because it has to be paid back in monthly installments with interest.
Credit Cards: Assets vs. Liabilities
Credit cards are a great example of how something can be both an asset and a liability. When you use a credit card to make a purchase, you’re using someone else’s money (the bank’s) to finance your purchase.
This can be helpful if you don’t have the cash on hand to pay for something outright. However, if you don’t pay your credit card bill in full each month, you’ll pay interest on your purchase, which can add up quickly. As long as you keep your balance below 30% of your credit limit, this shouldn’t be too much of a problem. But carrying any more than that is just asking for trouble.
Regarding your finances, it’s essential to understand the difference between assets and liabilities. Assets are anything that you own that has the potential to increase in value, while liabilities are anything that you owe. By understanding this distinction, you can make smarter decisions about how to use your money. For example, if you’re investing for retirement and have a 401(k) or IRA account, any money that goes into these types of accounts is an asset. Conversely, any debt accrued is considered a liability if you borrow money from a bank by taking out a mortgage or home equity loan to buy a house or car.