Assets and liabilities: getting to know the basics
When you’re starting and running a business, it’s important to understand the difference between assets and liabilities: in simple terms, assets are items you own that bring value to your company, whereas liabilities are what you owe to other parties.
Liabilities vs. expenses: what is the difference?
The main difference between liabilities and expenses is that liabilities impact your equity and expenses impact your cashflow. Liabilities are financial obligations that detract from your business equity, whereas expenses detract from your business income.
Expenses are costs that businesses typically pay for as they occur, while liabilities may be both short- and long-term. Expenses can become liabilities if payment is delayed, or if you take out a loan to pay for an expense.
What are business liabilities?
All businesses need to take on some liabilities to operate effectively. However, as a business owner you need to monitor your liabilities closely to make sure you have enough liquidity to cover them. Here are some examples of what your business liabilities could be:
Short-term liabilities are your financial obligations that are owing within 12 months. Some examples include:
wages that employees have earned but you’ve not yet paid
accounts payable owed to suppliers
any service or product you owe someone who has already paid you for it
payments for loans, hire purchases or credit in the next 12 months.
Long-term liabilities are debts or potential risks that a business must meet in more than a year’s time. Some examples include:
product warranties that you may have to fulfil for customers
deferred credits or revenue
deferred tax liabilities
the balances of loans and hire purchases beyond the next 12 months.
What are business assets?
Business assets are items of value that a business owns or controls that it expects will generate financial benefit over time. Assets can be tangible or intangible items. Here are some examples of different types of assets:
Current assets are liquid assets — they can be quickly and easily converted into cash. Some examples include:
business bank account balances
debts or invoices owed to you.
A business owner purchases fixed assets to produce income and doesn’t expect to sell these tangible items within a year. Some examples include:
Intangible assets aren’t physical in nature but nonetheless create value for your business over the long term. Some examples include:
How to account for assets and liabilities
You need to include your assets and liabilities on your balance sheet at the close of each accounting period. The purpose of completing a balance sheet is to ensure your assets are equal to your total liabilities and owner’s equity.
The two halves of your balance sheet must balance, because your assets are funded through your liabilities and owner’s equity. Equally, all profits are recorded as retained earnings in your owner’s equity, and this is balanced out on the asset side as cash.
If your balance sheet doesn’t balance, then you likely have a mistake somewhere in your ledger. Look for these common errors:
duplicate ledger entries
incorrect date for a ledger entry
incorrect inventory figures
With your balance sheet serving as as assets and liabilities statement, it’s easy to determine a business’ net worth: Assets - Liabilities = Net Worth.
As a balance sheet provides a snapshot of what a business owns and owes at a specific point in time, it can be useful (when used alongside the income statement and cashflow statement) for prospective investors to understand a business’ financial health.
Simplify your accounting with MYOB
If all this financial speak is over your head, you’re not alone. But with MYOB’s accounting software, we have you covered — you can generate your Balance Sheet at the click of a button and also invite your accountant or bookkeeper to your software for their help if you need it.
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