Assets vs. Liabilities

Assets generate income and appreciate in value, while liabilities drain resources and depreciate over time.

Do you want to improve your net worth? Probably so. But if you’re like many people, you might not know how to do that.

Increasing your net worth boils down to one thing: you need more money coming in than going out. To do that, you need to understand assets vs. liabilities. 

What Are Assets?

Assets are items or other resources that financially benefit you or your business. Some common ones are real estate, cash and investments. Assets can increase your net worth or your business’s value, and they are generally recorded on the left side of a balance sheet.

Example of Assets

Assets can be divided into four main classes:

• Fixed assets: Resources that should last more than a year (buildings, vehicles)
• Current assets: Resources that will likely be turned into cash within a year (accounts receivable, inventory, cash)
• Intangible assets: Non-physical assets like patents and trademarks
• Financial assets: Investments like stocks, corporate bonds and preferred equity

Bear in mind that some assets are easier to value than others. For instance, appraising a company car is a lot easier than determining the monetary value of a trademark.

What Are Liabilities?

Liabilities are sums of money or items that you or your company owe. On a company or individual balance sheet, liabilities are recorded on the right side. 

If you’re handling finances for a company, you may divide liabilities into current and long-term obligations. Current liabilities need to be paid within the year, and long-term liabilities are due later. The bottom line is that liabilities have a negative impact on your net worth or your business’s total value.

You also should keep track of contingent liabilities. These are liabilities that may or may not surface in the future. Product warranties are a great example — you don’t know the exact future cost of honoring warranties, but you know it will likely cost your business something.

Example of Liabilities

Here are some potential liabilities for individuals and companies:

• Real estate taxes on properties like houses or commercial buildings
• Existing mortgages
• Payroll for employees
• Various expenses like utilities
• Business loans, credit cards and other lines of credit

Keep in mind that you also might hear people use liability to describe legal risk. For example, contractors will typically secure liability insurance to cover them if they accidentally damage a customer’s property.

Differences Between Assets and Liabilities

Sometimes, assets and liabilities can be closely related. For example, if you own a house, that house would be considered an asset. But if you are still paying a mortgage on the house, the mortgage is a liability.

Depending on who you are, the same item can be either an asset or a liability. For example, if you’re a homeowner, your mortgage is a liability. But if you’re the lender, the mortgage is an asset.

The easiest way to tell whether something is an asset or a liability is to think of it this way: assets earn you money, and liabilities cost you money.

Importance of Building Assets and Reducing Liabilities

For individuals and businesses, increasing your assets and reducing your liabilities can lead to increased opportunities and greater financial well-being. 

If your personal assets outweigh your liabilities, you’ll be able to build wealth and increase your net worth over time. But if your liabilities outweigh your assets or come close to doing so, you may face constant financial stress. You also might have limited opportunities. For example, if you have excessive credit card debt, it may be difficult for you to purchase a house or get a reasonable rate on a car loan.

Even if you currently have more liabilities than assets, there are tangible steps you can take to improve your net worth. Here are some ways to start building assets:

• Invest in education and/or pursue a higher-paying job or career path
• Create a detailed budget
• Build a sizable savings account
• Increase contributions to your retirement account

And here are some ways to start reducing liabilities:

• Work on paying off debt, especially high-interest debt
• Make sure you’re taking advantage of every tax break you can
• Look closely at your insurance policies (home, auto, renter’s, etc.) and see if you can reduce your premiums without severely reducing coverage

If you want more personalized advice tailored to your financial situation, you might consider working with a qualified financial adviser.

Evaluating Assets and Liabilities in Personal Finance and Investing

Before you can determine your net worth, you need to determine the value of your assets vs. liabilities. It’s generally easier to calculate your liabilities — it’s easy enough to see how much you owe on credit cards, mortgages and car loans.

But what about assets? Their value may be a little harder to determine. First, make sure you’re considering every asset you can. These are some of the things you should include:

• The value of your investment accounts
• The value of your car
• Your home’s current market value
• Money in your checking and savings accounts
• Any business interests you own
• Valuable personal property like jewelry or art 

If you just want a rough estimate of your net worth, you can do a little digging around and estimate the value of each asset on the list. But if you want a very accurate determination of your net worth, you might want to have your home, car and other pieces of valuable property appraised.

To determine your net worth, you just need to subtract your total liabilities from your total assets. Because it takes your financial obligations into account, your net worth is a better metric for determining financial health than your income alone.

The more aware you are of your current net worth, the easier it will be to increase it. One way to keep tabs on your net worth is to periodically calculate a personal balance sheet. This works a lot like a company’s balance sheet — it summarizes your total assets and total liabilities and gives you an estimate of your net worth at a given point in time.

Reducing your spending can be a great way to start building net worth, so you also might find it useful to get what’s known as a personal cash flow statement. This is a statement that records all incoming and outgoing cash. Incoming cash might include the following:

• Your salary/wages
• Interest you’ve earned on a savings account
• Dividends and capital gains you’ve earned

A cash flow statement shows more than just your liabilities. It details all of your expenses, including the following:

• Rent or mortgage payments
• Utility payments
• Groceries
• Gas
• Entertainment and other discretionary spending

Remember that creating and sticking to a budget can help you minimize your cash outflow, creating more wealth over time.

Building Net Worth for a Stronger Financial Future

Maximizing your assets vs. liabilities will open up a world of new and exciting opportunities. And if you’d like some guidance along the way, Benzinga is here to help. You’ll find detailed how-to articles, investing guides and forums to help you start building your net worth. Take a look around today.

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