Assets vs. liabilities

The primary difference between assets and liabilities is the former is what a business owns, while the latter is what a business owes. Assets are economically beneficial and include items such as inventory, equipment, cash and short-term investments. Liabilities are the services a business hasn’t yet completed and the money it owes.

To be successful, a company must have more assets than liabilities. A business with more liabilities won’t be able to repay its debts and should consider taking swift action to improve cash flow.

What is the accounting formula?

The accounting formula is a representation of a business’ finances in the form of assets, liabilities and owners’ equity. It allows decision-makers to determine the amount of money a company has in each category. Typically, professionals in financial roles, such as accountants, use the accounting formula to complete company balance sheets. However, in a small business or sole proprietorship, a senior manager or the business owner may complete these calculations.

The accounting formula is as follows:

Assets = Liabilities + Shareholder’s Equity

When adding total liabilities and total equity, the result should equal total assets. If the two figures aren’t equal, review your calculations to make sure you entered everything accurately. Check each account on the balance sheet and compare it to your company’s financial documents to see if you missed anything. This can help ensure you report the correct figures when completing your taxes or in case of a financial audit.

For example:

After checking your balance sheet and making the necessary calculations, you determine you have $300,000 in total assets, $250,000 in total liabilities and $50,000 in shareholder’s equity.

This is how the formula should look:

$300,000 = $250,000 + $50,000

$300,000 = $300,000

What is an asset?

An asset is anything of monetary value that’s owned by your company. Assets contribute to daily business operations and promote financial growth and stability. There are two key types of assets: 1) current assets and 2) noncurrent or long-term assets. A current asset is one your company expects to consume, use or convert into cash within one fiscal year, while a noncurrent asset is one your organization will own for a period longer than one fiscal year.

Below are some examples of current and noncurrent assets, and information about how to calculate them:

Examples of current assets:

• Cash
• Accounts receivable
• Stock inventory
• Prepaid liabilities
• Short-term investments (treasury bills, high-yield savings accounts and government bonds)

Examples of noncurrent assets:

• Equipment
• Property or land
• Intellectual property
• Copyrights or trademarks

Calculating assets

When calculating assets, use the standard accounting formula or the following equation:

Total Assets = Current Assets + Noncurrent Assets

To find your company’s total assets and compare them to liabilities and shareholder’s equity, first identify the different types of assets on your balance sheet. Once you locate your total current and noncurrent assets, add them together to calculate total assets.

For example:

Total Assets = $100,000 (Current Assets) + $200,000 (Noncurrent Assets)

Total Assets = $300,000

What is a liability?

Liabilities include any debts a company owes to consumers, partners or institutions. Similar to assets, liabilities can be separated into two key categories: 1) current liabilities and 2) noncurrent liabilities. Current liabilities include any debts your business needs to pay off within one fiscal year, while noncurrent liabilities include any obligations that won’t be repaid within one fiscal year but over a longer period.

Here are examples of current versus noncurrent liabilities:

Examples of current liabilities:

• Accounts payable
• Dividends
• Wages
• Income tax
• Short-term bank loans
• Notes payable

Examples of noncurrent liabilities:

• Bonds payable
• Retirement payments
• Debentures
• Deferred taxes
• Long-term loans

Liabilities vs. expenses

It’s important to distinguish between liabilities and expenses, which are similar but have key differences. First, an expense is listed on a company’s income statement and represents the costs associated with operating your business. Crucially, expenses can be paid immediately with cash. Delaying payment of an expense would create a liability.

By subtracting expenses from revenue, you can calculate your company’s net income—and if expenses are higher than revenue, your organization may be in financial trouble.

Expenses:

• Found on the income statement
• Closely linked to revenue
• Costs associated with running a business and generating revenue

Liabilities:

• Found on the balance sheet
• Monies owed now or in the future
• Obligations and debts

Calculating liabilities

You can calculate your company’s liabilities using the following formula:

Liabilities = Assets – Shareholder’s Equity

To determine the total amount of your company’s liabilities, find the figures for total assets and equity on the balance sheet. You may need to apply the equity formula before proceeding.

For example:

Liabilities = $300,000 (Assets) – $50,000 (Shareholder’s Equity)

Liabilities = $250,000

What is equity?

Equity or shareholder’s equity represents the approximate amount of money that would be left over if you liquidated all your company’s assets to pay off its liabilities. This also represents the hypothetical amount that shareholders would receive in exchange for their investment.

Here are some examples of equity:

• Retained earnings
• Preferred stock
• Common stock
• Paid-in capital

Calculating equity

You can calculate equity using the following equation:

Equity = Assets – Liabilities

To determine the amount of equity you could potentially have for investors, identify the totals for assets and liabilities. You can typically locate these figures at the bottom of the balance sheet.

For example:

Equity = $300,000 (Total Assets) – $250,000 (Total Liabilities)

Equity = $50,000

The importance of the accounting equation

Understanding equity, assets and liabilities for business is essential for any operator using the double-entry bookkeeping system. The accounting equation ensures that balance sheets are balanced and every record is accurately recorded. It also helps shareholders understand how much their investment is worth in case of liquidation.

Being familiar with these generally accepted accounting principles (GAAP) and what they mean is crucial for business leaders to be able to run a profitable operation with healthy cash flow.

FAQs about assets and liabilities for business

Is land an asset or liability?

Land is a fixed, long-term asset because the amount of time you’d typically expect to own it is likely longer than one year. The exception would be if you expect to liquidate the land within the next fiscal year. Land can’t be depreciated, and it’s usually a company’s longest-lived asset.

What is a contingent liability?

Contingent liabilities are something of a gray area because they reflect potential liabilities that could occur in the future. Product warranties, potential lawsuits and pending investigations are examples. When it’s possible to estimate a contingent liability, you should record it on the balance sheet. If it can’t be approximated, you’ll need to disclose it.

How do assets relate to liabilities and equity?

The value of a company’s total liabilities is equivalent to the sum of the difference between total assets and equity. Therefore, even though the accounting equation proposes that assets = liabilities + equity, it’s also possible to reconfigure the formula to liabilities = assets – equity. If your business accumulates more liabilities in lieu of generating more assets, its equity position is reduced.