Assets vs. liabilities: What are they?

The balance sheet (or statement of financial position) is one of the three basic financial statements that every business owner analyzes to make financial decisions. A balance sheet reports your firm’s assets, liabilities, and equity as of a specific date. 

But what are assets and liabilities and what sets them apart? Below we’ll cover their basic definitions and functions, how they factor into the balance sheet and provide some formulas and examples to help you put them into practice.

• Overview: Assets vs. liabilities
• What are assets?
• Current assets
• Noncurrent assets
• What are liabilities?
• Current liabilities
• Noncurrent liabilities
• Liabilities vs. expenses
• Assets, liabilities, and equity
• Example of how to use assets and liabilities in practice
• Use cases
• Example

Overview: Assets vs. liabilities

Assets are a representation of things that are owned by a company and produce revenue. Liabilities, on the other hand, are a representation of amounts owed to other parties. Both assets and liabilities are broken down into current and noncurrent categories.

In short, one is owned (assets) and one is owed (liabilities).

What are assets?

Assets usually appear on the left side of the balance sheet and are defined as income-producing resources. For instance, these could be categorized as an asset by definition:

• Property
• Equipment
• Cash 
• Marketable securities
• Retirement plans
• Mutual funds
• Savings accounts

But “assets” isn’t an all-encompassing term. It’s broken down into two types: current assets and noncurrent assets. Let’s take a look at each type of asset and explore how they affect the overall assets of a company on its financial statements. 

Current assets 

Current assets are a representation of assets including cash and objects that will be converted into liquid assets within 12 months. These assets can include:

• Cash and cash equivalents: The total amount of cash on hand. Cash equivalents refer to short-term, high-quality investments, including certificates of deposit (CDs) and commercial paper.
• Accounts receivable: The amount that your customers owe you after buying your goods or services on credit.
• Inventory: Items purchased for resale to customers.
• Prepaid expenses: Expenses you’ve paid in advance, such as six months of insurance premiums. These cash payments are assets because the cost has already been incurred.
• Investments: Money market account balances, stocks, and bonds. Some investments may be categorized as noncurrent, but most are current assets. Investments in this category are also defined as marketable securities.
• Notes receivable: Amounts you are owed that will be paid within 12 months.

Current assets are important because they can be used to determine a company’s owned property. This can provide the necessary information behind how much liquid funds they could produce in the event that those assets had to be sold.

Noncurrent assets 

Noncurrent assets, or non-operating assets, will not be converted into cash within a year, as they are more long-term assets. These could include two different types of assets:

• Fixed assets: Fixed assets, or tangible assets, include vehicles and equipment used to produce revenue. These assets decrease in value over time. For that reason, depreciation expense is posted to record the decline in the value of fixed financial assets. Real estate (land) is posted to the fixed asset category, but the land does not depreciate in value.
• Intangible assets: Assets that have no physical manifestation, such as copyrights, patents, and intellectual property fall into this category.

What are liabilities?

Liabilities are amounts owed to third parties and generally follow assets on a company balance sheet. In some cases, they’re grouped in with shareholders' equity, but they’re listed in the order in which they need to be repaid. Liabilities include:

• Accounts payable
• Interest payable
• Long-term debt
• Accrued expenses

As with assets, there are two different types of liabilities: current and noncurrent. 

Current liabilities

Current liabilities are amounts due to be paid within a year and are recorded nearest the top of the balance sheet. Some examples include:

• Accounts payable (amounts you owe suppliers)
• Payroll liabilities
• Amounts due on short-term business loans, such as a line of credit
• Credit card balances
• Income tax liabilities 

Current liabilities are important because they can be used to determine how well a company is performing by whether or not they can afford to pay their current liabilities with the revenue generated. A company that can’t afford to pay may not be operating at the optimum level. 

Noncurrent liabilities 

Noncurrent liabilities are amounts due to be paid in a year or more, such as:

• Long-term loans
• Mortgage payments
• Vehicle payments

These liabilities are noncurrent, but the category is often defined as “long-term” in the balance sheet. Companies will use long-term debt for reasons like not wanting to eliminate cash reserves, so instead, they finance and put those funds to use in other lucrative ways, like high-return investments. 

Liabilities vs. expenses

Expenses and liabilities are not interchangeable terms. Liabilities are the debts and amounts owed to other parties. Expenses are the costs required to conduct business operations and produce revenue for the company.

Liability: 

• Recorded on the balance sheet
• Can be classified as debt and needs to be repaid
• Can be repaid over time and can be delayed

Expense:

• Recorded on the income statement
• Used to produce income, like operating expenses
• Can be paid immediately

Assets, liabilities, and equity

Assets, liabilities, and equity are the components of a balance sheet. Here’s the breakdown:

• Total assets: What your business owns. Assets are resources used to produce revenue and have a future economic benefit.
• Liabilities: Amounts your business owes to other parties. Liabilities include accounts payable and long-term debt.
• Equity: Equity is the difference between assets and liabilities, and you can think of equity as the true value of your business.

Their relationship can be seen in the balance sheet formula below:

Assets = liabilities + equity

This formula is used to create financial statements, including the balance sheet, that can be used to find the economic value and net worth of a company.

Example of how to use assets and liabilities in practice

Different industries utilize assets and liabilities differently. Some may shy away from liabilities while others take advantage of the growth it offers by undertaking debt to bridge the gap from one level of production to another. Here are some of the use cases you may run into when understanding the uses of assets and liabilities.

Use cases

The details in the balance sheet allow a financial institution to perform financial analysis including:

• Liquidity: The ability to generate sufficient current assets to pay current liabilities
• Solvency: The ability to meet the company’s obligations in future years
• Debt-to-equity ratio: Tracks increases and decreases in liabilities as a percentage of equity
• Accounts receivable turnover ratio: Measures the company’s speed on collecting AR income 

Example

Assets on the left side of the accounting equation must stay in balance with liabilities and equity on the right side of the equation:

Assets = liabilities + equity

Assume that a firm issues a $10,000 bond and receives cash. The company posts a $10,000 debit to cash (an asset account) and a $10,000 credit to bonds payable (a liability account).

Here’s the impact on the equation:

$10,000 increase assets = $10,000 increase liabilities + $0 change equity

Using accounting software can help ensure that each journal entry you post keeps the formula in balance. If you use a bookkeeper or an accountant, they will also keep an eye on this process.

Assets and liabilities for better decision-making

Assets and liabilities are key factors to making smarter decisions with your corporate finances and are often showcased in the balance sheet and other financial statements. Accounting software can easily compile these statements and track the metrics they produce. 

The balance sheet is one of three financial statements that explain your company’s performance. Review your balance sheet each month, and use the analytical tools to assess the financial position of your small business. Using the balance sheet data can help you make better decisions and increase profits.