So, you have taken that big bold step into the world of entrepreneurship, or perhaps you're seriously contemplating starting up your own business. Well done I say; indeed, you are certainly on the right track! By now in your entrepreneurship journey you would have been hearing some phrases, technical terms and buzz words, like Assets, Liabilities and so on … These sometime get you all worked up and you wonder what do these words really mean? Well I have good news for you, friend. You are at the right place.
In these two-part series Finance 1O1, I would be breaking down the meaning of an asset, and in the next part of the series, we would be discussing the term "Liability". By the end of this article, you would be able to understand:
- The definition of an asset
- Types of assets and,
- Some examples of assets as they relate to your business.
Now that we have gotten that out of the way, let's dive straight in.
What is an asset?
The Oxford English dictionary defines an asset as follows
"A useful or valuable thing or person"
it further goes on to define an asset as
"An item of property owned by a person or company, regarded as having value and available to meet debts, commitments, or legacies."
From these definitions, am sure you get the picture that in the business context, an asset is anything owned by and used by a business. let us now proceed to give a comprehensive definition of an asset from an accounting and finance point of view. The International Accounting Standards Board (IASB) defines an asset as:
"A resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity" (IASB Framework).
Let us look at the business of Mrs. Pelz (Pelz Socks). Pelz is in the business of selling socks, so he buys a delivery motorbike in order to make deliveries to his customers, by doing so he is able to increase his sales and generate revenue. In this context the motorbike is an asset. It is an asset because it was bought by Mrs. Pelz (Control /ownership), to reach more customers (future economic benefit) and finally to increase sales or generate more revenue (Flows to the entity Pelz socks).
Types of Assets
Now that we have looked at the meaning of an Asset, let us now go on to see the types of Assets.
There are two types of Assets:
- Current Asset.
- Non-current Asset.
Current Assets are cash and other assets which are reasonably expected to be turned to cash within a year. Current assets are utilized for the operations of the business. Current assets include receivables, inventory. Current assets are also called short term assets and they appear in the financial statements (Statement of financial position) as follows
- Cash equivalents
- Stock Inventory
Non-current assets are assets that have a useful life of more than one year. They cannot be easily converted to cash. and as such are considered to be illiquid. Noncurrent assets appear in the financial statements (Statement of financial position) as follows:
- Property Plant and equipment
- Long term investments
- Intangible assets
Non-current assets are subject to depreciation over their useful life span.
To help us understand the types of assets let us consider the example of Mr. Tops who runs a barber shop "Tops Cuts". Tops Cuts has cash in the bank balance of N2,000,000, this is mostly from accurate proceeds of hair cuts carried out through the month. Tops Cuts is also owed a sum total of N300,000 from various clients who would normally pay at the end of the month.
Mr. Tops purchased a shop which he uses as his barbing saloon, he also purchased 5 barbing chairs and equipped the shop with some amenities such as Air conditioner, mirrors, sterilizing kits, towel racks etc. from the proceeds of the business. Tops decided to invest some total of N1,500,000 in long term investments.
In this scenario the (remaining cash balance of N500,000, after removing the amount invested in long term investments) as well as the N300, 000 are short term assets, because they are in cash or are expected to be in cash within a year (in this case at the end of the month).
Whilst the shop along with the fixtures (property plant and equipment) as well as the long-term investments Mr. tops invested in are Non-current assets because they have a life span of more than one year, and may not be easily converted into cash if the need arises.
In this write up, we have considered what an asset is. We have also gone on to discuss the types of assets and finally we have been able to apply simple examples to help us understand the concept of assets, better. My hope is that the next time you hear the "buzz word" Asset you would have a firm understanding of what it is.
Next stop we will be looking at the term Liability, want to know more? Then please be on the lookout for the part two in these series. Finance 101 (part 2) What are Liabilities. Till then keep on keeping on.