Assets and liabilities: A Comprehensive Exploration with Real-Life Scenarios

Embarking on the journey of understanding assets and liabilities can be transformative, opening the doors to financial enlightenment. In this article, we steer away from mundane textbook definitions, opting instead for a practical approach aimed at those seeking real-world financial security, not just for themselves, but their families as well.

Today, we delve into the Great Divide between wealth and poverty- Assets Vs Liabilities.

While the basics of assets and liabilities may be familiar to anyone with a grasp of basic accounting, few truly grasp the practical application of these concepts. The essence lies not in the raw form of an entity but in its utility—a house is a house, a car is a car, but what you do with each determines whether it becomes an asset or a liability.

What is an asset and what is a liability?

As mentioned, I am not just going to quote theoretical definitions for you but give practical renditions of the concept and present you with illustrations that would not just grant you a crystal clear understanding but prepare you to immediately start implementing this system in your life

When teaching this topic, I usually illuminate the fact that no entity is called an asset or liability in its raw form. It is the utility of an entity that gives such a designation. For instance, a house is a house. A car is a car. What you do with each will either make it an asset or a liability.

Generally speaking, the simplest definition is that an asset is anything that brings money into your pocket while a liability takes money out of your pocket.

There are several other definitions which I won’t bore you with and I know the above definition is completely over-simplified.

So, to ensure a more meaningful understanding let’s explore the features of an asset and a liability.

Features Of Assets And Liabilities

For any entity to be classified as an asset, it must possess these three qualities:

1. It must be something you have control over
2. The control must have resulted from a previous transaction
3.  It must have a future economic value, thus a positive net profit

The last point is the most important. In a bit, we will take a few practical illustrations. But before that let’s quickly outline the features of a liability

1. It Presents the individual or business with an obligation
2. The obligation is a result of a previous event
3. Fulfilling the obligation will cause an outflow of cash/resources

Now we are going into our much-awaited illustrations, Before that, if you are getting value so far, like, comment and share this article right now.

Practical Illustrations

Illustration One:

Assuming Mr A has £50,000 and decided to buy 5 Kia Rio vehicles with which he made the business decision to set up a transportation company.

Now, let us analyse this transaction using the features of an asset stated above;

Does Mr A  have control over the cars?

Yes, he does have control

Is the control as a result of a previous event?

Yes. He gave out the £50,000 in exchange for the cars.

Is there a future economic value with the potential to generate a net profit?

Definitely. Once his transportation business picks up, and he can break even and become profitable, and positive cashflow ensues

These cars therefore qualify as assets. Would you agree?

Illustration Two:

Now assuming Mr B also possesses £50,000 in his bank account. In his case, he chose to buy the latest Range Rover car for his personal use.

Let’s do the analysis once again as done in the first scenario.

One would realize that Mr B  does have control over his newly acquired Range Rover; resulting from a previous activity. However, as long as he is only using this car for personal everyday rounds, the expenses on maintenance and fuelling push this entity in the liability column as there is no future possibility of net cash inflow from directly using the car

To reaffirm this, let’s revisit the features of a liability

Does the Personal use of the Range Rover present an obligation? Yes

Is the obligation a product of a previous event? Definitely

Will settling the obligation require an outflow of cash? Your guess is right

I believe by now you are gaining a deeper understanding into the discourse.

Now let’s test your understanding.

You just started your business and went for a loan of £5000 to grow your business. Is the loan a liability or an asset?   Pause, do the analysis then come back

This loan is a liability, as paying it back with the interest will require an outflow of cash.

Now assume you used this money to acquire new computers purposely for incoming generating activities of your business. Are the computer’s assets or liabilities?

These computers are definitely assets. Provided they serve their purpose, they will generate a net positive cashflow to the business.

So, the loan will stay a liability until you pay it off, while the computers stay in the assets column. These two are distinct transactions. Using the loan to acquire the computers doesn’t change the loan status as a liability.

Introduction To Types Of Assets

Tangible assets possess a physical presence, allowing them to be observed, touched, and felt. They are also referred to as fixed assets and encompass items like land, buildings, and machinery.

In contrast, intangible assets lack a physical form but can be quantified and converted into cash under the right circumstances. Examples include intellectual properties, human network or social capital, goodwill, as well as financial assets like shares, stocks, equity, securities, and cryptocurrencies.

It’s important to note that this classification is a simplified one, and online information may present variations. However, our primary goal is to streamline these concepts for practical application by individuals.

I recommend you watch This Youtube Video which comprehensively discusses the types.

Assets Any Young Person Under 40 Years Should Know!

One: Social Capital

One of the most underrated assets. The money/customers/open doors you want are all in the hands of other people. As a young person invest time and resources into expanding a quality social  and professional network

Two: Intellectual Property

Having monetizable skills and knowledge, especially outside the confines of your day job is the greatest asset you can have as a young person. Luck is what occurs when opportunity meets preparation. How prepared are you? What do you have to offer?

Three: Land

This is the simplest fixed asset to acquire in your 20s and 30s. Do not think about what you will use it for. Land in itself has a naturally growing economic value. For instance, I recently purchased a plot of land and within a space of six months, the price of the land literally doubled. Imagine the value of that land in the next five years.

Four: Financial Assets

In this internet era, investing in financial assets with as little as £10/monthly investment is becoming easier.

In conclusion, understanding the intricate dance between assets and liabilities requires a nuanced approach. The practical examples provided aim to equip you with the tools to navigate this financial terrain confidently. As you continue on your financial journey, remember that the choices you make with your resources determine whether they become assets that fuel your prosperity or liabilities that deplete your financial reservoir.