What are Assets and Liabilities?
Knowing the difference between an asset and a liability is important for every member of management, mostly due to the fact that these are both used when putting together a ‘Balance Sheet’ for the company.
While you may not be an accountant or even in the accounting department, knowing the difference will make it much easier for you to understand the normal, day to day affairs of your organization. Such knowledge can even make you more attractive when the time comes for you to be considered for a promotion… which can lead to higher pay and a more desirable title.
Business owners and upper-level managers are always looking for first-level management that understand the ins and outs of business… not just how to manage personnel or get a job done. Knowing as much as you can about the cash-flow, language, and nature of the business will definitely give you an advantage over others who may be vying for the same position.
So what is the difference between an asset and a liability? That is a great question, and we are going to talk about it in the next part of this article.
What is an Asset?
Assets are basically divided into two different categories. These are known as ‘current assets’ and ‘fixed assets’. Current assets can generally be categorized as assets that can either be…
- Used to pay liabilities within a 12 month period
- Converted to cash, either instantly or within 12 months
Cash, stock inventory, accounts receivable, and short term investments are some examples of what a current asset is. On a balance sheet, these types of assets are generally categorized differently than fixed assets, which are usually categorized as assets that cannot be easily converted into cash like current assets can.
In fact, one term that is often used in conjunction with fixed assets is ‘PP&E’, or ‘Property, Plant, and Equipment’. These are just a few examples of what you could find in the ‘fixed asset’ category on a company’s balance sheet.
A lot of people, for example, claim that their house is an asset. Why? Well, because they could sell it and, rather reliably, make back a certain amount of money on it. The difference between a house and cash, however, is that cash can easily be used to pay liabilities within a 12 month period.
All you have to do is write a check, initiate a bank transfer, or literally hand over some cash. A house, on the other hand, while it CAN be sold and then the money used to pay for liabilities, is not so easy to convert to cash on short notice. You will, after all, need to go through the motions of selling the house before you will have access to the cash. That is why a house is technically a ‘fixed asset’, or what could also be called a ‘non-liquid asset’.
What is a Liability?
You could say that a liability is any obligation to pay an entity for either a past or future event. Business loan payments, for example, fall into the realm of liabilities, as do payments that must be made to others who have provided services for you that are intended to improve your business.
In theory, you need your assets to outweigh your liabilities if you want to be successful. That, or you need to have the necessary cash or assets in hand to float you by until they do. Building a balanced budget is all about looking at your liabilities and assets. Companies are, in general, looking for ways to acquire more assets, which generally translates into more cash and, in turn, more wealth.
Understanding Finance and Accounting Will Help Your Career
As a manager, you most likely have a drive to move forward in your career. You probably want more responsibility, more authority, a better position, and in the end… more pay. You may even want to climb to the top of the ladder! To achieve the recognition you deserve you need to be fluent in ‘financial speak’ so that you can converse with senior managers, CPA’s and accountants at their level. It is essential that you know and can talk about the difference between ‘net sales’ and ‘net income’ is more important than you may think.
There are a variety of reasons why you need to be comfortable expressing yourself and your ideas in accounting terms. There are several reasons as to why learning the lingo is important to getting further ahead, and here are a few of the most significant benefits you can attain by displaying financial awareness competency.
1. You can make a valued contribution to strategic decisions.
If you think that business is all about being creative and managing people, then think again! You need to be able to plan for everything to be successful, and this means being able to gauge the financial outlook of a potentially risky venture before stepping out. Our eBook ‘Financial Performance’ explains how to use Key financial ratios to help you to make informed management decisions about the financial status of other organizations.
By acquiring a working knowledge of financial terminology you will feel comfortable if your boss hands you a financial report and asks you to review it for him and deliver an opinion. Trust me… it is NOT going to look very good for you if you need to ask what ‘operating income’ is as it pertains to that report you were assigned to read!
Knowing the ins and outs of finance terms is going to make you much more valuable to your organization, which is what helps you get promoted.
2. You are seen as a valued member of the management team.
The second benefit to you is you are seen as a valued member of your organization’s management team and harder to replace than someone without this knowledge. By committing yourself to learn and understand financial terminology you will be perceived as someone who puts in that extra effort to be part of a winning team. The more value you bring your organization the harder you are to replace.
3. You act and sound like a senior manager or executive.
Finances are a huge part of any organization and being able to converse confidently and accurately in financial discussions will show you have this senior management competency. The truth is simple… your boss is not going to promote someone who is not financially savvy!
At some point, if you want to move forward, knowing this terminology is going to be essential to you becoming a more integral part of the process. You will only be able to help so much if you can’t follow a conversation without asking what ‘market risk’ is, or without knowing what someone means when they talk about ‘face value’.
Developing your competency in this area increases your value to the organization and raises your own self-esteem. It also makes you a more attractive commodity for other organizations if you chose to switch careers.
Free Accounting Concepts eBook
Check out our free Accounting Concepts eBook, which explains all of the basic accounting concepts and terminology you will need to understand financial statements internal monthly reports. It contains the following chapters:
Chapter 1 – Accounting Concepts and Conventions
Chapter 3 – Cash Accounting
Chapter 4 – Accrual Accounting
Chapter 5 – Basic Accounting Terms
Chapter 6 – Revenue Recognition Principle
Chapter 7 – Matching Principle
Chapter 8 – Example Income Statement
This free eBook will teach you: The precise meaning of the essential accounting terms, the purpose of the income statement, balance sheet and cash flow statement, the differences between cash based and accrual based accounting, the ‘revenue recognition’ principle and the ‘matching’ principle, and how depreciation, prepayments and bad debt are allowed for.
- You should make sure that you know the basic concepts and terminology needed to understand income statements, balance sheets, and statements of cash flow as these are widely used, even by nonprofit organizations.
- Terms like ‘revenue,’ ‘expenses,’ ‘gross profit,’ ‘depreciation,’ ‘bad debt,’ and ‘fixed assets’ have precise definitions when used in business accounting.
- You need to understand exactly what is meant by accounting terms like these.