Understanding Basic Accounting Terms and Concepts: Week 1 - Assets
Hello - Welcome to Financial Friday Week One: Assets
Today we continue with the Understanding Basic Accounting Terms and Concepts series introduced in the last post with the topic of ASSETS.
In the world of finance and accounting, assets play a pivotal role, constituting the value owned by a business. For small business owners seeking to enhance their financial literacy, understanding assets is fundamental. Assets refer to any resources owned by a business that can be used to produce value, either by generating revenue or reducing expenses.
Classification of Assets
Assets are generally classified into two main categories:
Current Assets: These are short-term assets, expected to be converted to cash or used within one year. Examples include cash, accounts receivable (what your clients and customers owe you), and inventory (the physical products your business sells).
Non-current Assets: These are long-term assets that are not expected to be converted to cash within one year. Examples include property, plant, and equipment (also known as fixed assets), and intangible assets like patents and trademarks.
Examples of Assets
Cash and Cash Equivalents: These are the most liquid assets. This is what all of your checking and savings accounts are classified as. Any funds kept in accounts like PayPal and Stripe would also be categorized as a Cash Equivalent.
Accounts Receivable: Amounts owed to the business by customers for goods or services provided on credit. When you create an invoice for your clients to pay you for your product, the amount owed is an Accounts Receivable (A/R) until paid. Depending on the type of accounting method used (cash, accrual, or a hybrid), your business may not have A/R.
Inventory: Goods available for sale. Any supplies used to produce your services are not held as inventory, but rather as an expense on the Income Statement.
Property, Plant, and Equipment (PP&E): Long-term tangible assets, such as buildings, machinery, and vehicles, used in the production or sale of goods and services. These items are usually over a threshold (each business may choose what this threshold is and should work with their accountant and tax preparer to determine if a purchase is an asset or an expense).
Intellectual Property: Intangible assets like patents, trademarks, and copyrights that provide competitive advantages.
How Assets Are Reflected on a Balance Sheet
A balance sheet provides a snapshot of a company's financial position at a specific point in time, detailing its assets, liabilities, and equity. Assets are displayed at the top of a balance sheet, and segmented into current and non-current assets.
1. Current Assets
These are usually listed first on the balance sheet, in the order of liquidity (how quickly they can be turned to cash):
Cash and Cash Equivalents
Accounts Receivable (accrual basis only)
Inventory (sellable goods)
Prepaid Expenses and Deposits
2. Non-Current Assets
Listed below the current assets, non-current assets generally include:
Property, Plant, and Equipment (PP&E)
Long-term Investments
Intellectual Property
Importance for Small Business Owners
Understanding assets is crucial for small business owners as it helps in:
Financial Analysis & Planning: Enables business owners to plan and manage their resources effectively, ensuring business sustainability and growth.
Risk Management: Provides insights into the financial health of the business, helping owners identify and mitigate risks.
Value Estimation: Offers a clear picture of the business’s worth, beneficial in negotiations for sales, mergers, or acquisitions.
Practical Tips for Small Business Owners
Maintain Accurate Records: Regularly update financial statements, ensuring they reflect the true value and quantity of your assets. Work with your accountant or tax preparer so they can help you determine what amount belongs on your balance sheet.
Asset Management: Efficiently allocate and utilize assets to optimize profitability and value generation.
Diversification: Consider holding a variety of asset types to spread risk and increase the potential for returns.
Conclusion
For small business owners, assets are the lifeline that fuels operations and growth. Understanding and managing assets proficiently can lead to enhanced financial stability and success. By consistently monitoring your assets through a well-maintained balance sheet, you can make informed decisions to propel your business forward in the competitive market landscape. Financial literacy, starting with a grasp of assets, is a stepping stone to entrepreneurial accomplishment.