Assets vs Liabilities
Financial literacy just isn’t complete without an understanding of cashflow
With all of the many aspects to financial literacy that exist, it’s not hard at all to get lost in the weeds of acronyms, rule-of-thumb recommendations, and all the other terminology and formulas. As part of our series to simplify the personal finance into easily digestible, macro concepts, I did not feel that it would be fair to you to skip over discussing assets and liabilities. It is not a fancy or “smart-sounding” phrase, though its simplicity speaks for itself, the true power of knowing these terms lies in how you apply that knowledge.
There is nothing to decipher or speculate with a phrase as plain and direct as “assets and liabilities”. It needs no specialized knowledge or long-winded explanation from a Ph.D.-level economist. For the readers who don’t know or understand why this phrase is such a life-changer, hopefully by the end of this article your view on how you see money will be much different.
What are assets? What are liabilities?
Assets and liabilities are more commonly known and used as a business term that references what the business owns and what it owes for example it’s sources of income and it’s debt. For businesses this information is listed on their balance sheet. The purpose of the business’s balance sheet is to give a snapshot of the overall financial health and standing of the company at that moment.
For purposes of personal finance assets and liabilities refer to a simplified classification of how to categorize your purchases. In essence, it is a rule-of-thumb method to understand the effect a particular effect a purchase has on your overall finances. While there are certainly other ways to quickly determine the impact a purchase has on your overall financial standing and net worth, this method doesn’t allow you to make excuses or justifications as easily for your purchases.
So, what is an asset?
An asset in the most fundamental sense is any item or entity that adds money to your income and puts money in your pockets. It could be as simple as math tutoring, or as complicated as running multiple small businesses. Assets can be either tangible or intangible. Examples of tangible assets include:
Shoes that are re-sold or flipped
A car that used on platforms like Turo
Real estate properties
Not all assets may fall into the category of tangible assets. Especially in with how technology has advanced in the last few decades, it’s gotten easier and more convenient to create and develop intangible assets. Some examples include:
Royalties from book sales
Royalties from sales of music
Ebooks
Stocks you own
Monetized blogs or podcasts
As you can see assets are any means by which your monthly income is bolstered by additional activities that you have been able to successfully monetize. Tangible assets are no more or less important than intangible assets, and more importantly there is no rule stating that you cannot have both types supplementing your income.
Why should you care about what an asset is?
Assets are what keep the lights on, and ideally fund you enjoying the life of your dreams! They are the core pillar of everything financial independence is built on!
Assets are part of the formula for determining your net worth. Your net worth is your “personal price tag” or to put it another way “what it would take to buy you out of everything you own”.
Financial literacy is built on understanding what an asset is, because without understanding, there is no clear, rule-of-thumb philosophy to determine whether a thing you own is helping or hurting your financial position. In many cases people assume that things are assets when they may not truly be money-generating (more on that in another article).
For the purposes of this article, the most important thing to understand about assets is that they are essentially financial “cheat codes” if you know what to look for! And the better you get at spotting a true asset, the better the quality of your life will become over time, and there is absolutely no limit on how many asset types you can own!
If you take nothing else away from this section on what assets matter, just remember ACA. Always Collect Assets!
So, what is a liability?
A liability at its most basic level is anything or entity that takes money out of your household finances. Liabilities are essentially any form of debt that you may owe, regardless of who it’s owed to. Liabilities come in all shapes and sizes; some common examples include:
Loans you owe to friends
Credit card debt
Bills
A snickers bar while you wait in line at the grocery store.
Liabilities for businesses are broken down into two categories, current and non-current liabilities. Current liabilities are considered debts owed within that fiscal year, whereas non-current are more long-term oriented debts, that are not yet due within the present fiscal year.
Just as with the business application of liabilities, applying it to personal finance fits near-seamlessly. Here’s how, in personal finance there is also a distinction between short-term and long-term liabilities. For example, short-term liabilities would include things like credit-card debt, secured or unsecured loans and payday loans. For longer-term liabilities like mortgages, student loans, and auto loans are debts that most people understand will take several years (if not decades) to pay off.
Why should you care about what a liability is?
Liabilities give you a very clear glimpse into your relationship with your finances. For example, your list of liabilities accentuates your financial missteps, and the consequences of potential financial impulsiveness. Although having liabilities does not automatically mean your finances are in disarray, it does however complicate your ability to collect assets. There are some instances in which debt can actually be a good thing, but for purposes of this article we are focused on maintaining a simple understanding of liabilities and as such, liabilities and debt are bad!
The accumulation of liabilities becomes an unavoidable issue once your liabilities once they begin to exceed your assets. Which ultimately leaves you with a negative net worth. (Which hopefully no one reading this wants, right?) Once liabilities start to exceed your assets, they can disrupt your finances like an invasive insect, interfering and gradually destroying your ability to create and sustain your financial goals.
In most cases, the faster you can eliminate your liabilities (again for the purposes of this article we are assuming all liabilities and debts are bad) the better off you will be financially. No matter how small your debts may seem, they are still sucking money out of your pockets and thus making you weaker and weaker financially. Which will leave you financially emaciated and unable to handle unexpected emergencies or even enjoy minor joys like an impromptu weekend getaway with friends.
THE BOTTOM LINE
Assets and liabilities are not complicated terms to understand, nor is it a vague, inexplicable concept. Simply put assets put money in your pocket consistently, while liabilities consistently take money out of your pockets.
Assets are all around and come in many different forms from stocks, and book royalties to rental income from real estate and income from a business you’ve started. The same can also be said about liabilities which can range from the “$20 for gas” you still haven’t paid back to that friend, to a mortgage on your home, even something as simple as a spotify subscription (sorry spotify).
Liabilities should be avoided as much as possible, (especially if you don’t have the necessary financial knowledge to understand the different types of debt, and how to leverage them). Whereas with assets, you should make it a life mission to learn about all the different types and spend every possible moment collecting as many as possible. One way to make sure that you are on the right track is to establish financial goals that (at the very least indirectly) incorporate acquiring assets.
FREQUENTLY ASKED QUESTIONS (FAQS)
Can something be both an asset and a liability?
The short answer is no. If something takes money out of your pocket, it is unlikely that it will reverse course and put money back in your pocket. There are some exceptions, though they are generally few and far between. This is one of the reasons why once you understand what to look for “asset-hunting” can be so beneficial.
When should i start focusing on collecting assets?
Even though you should always be on the lookout for assets, the best thing to do is to properly establish and fund your emergency fund and ensure that your personal finances are in the strongest possible position. Take it from me, the worst feeling in the world is to have to sell your stock shares, because you didn’t remember that Netflix and Disney+ were due, and you’re now scrambling to cover the negative balance before you get an overdraft fee added. (A situation I do not recommend putting yourself in).
What if I don’t see anything i think is an asset?
In the words of Sandy Cheeks, “Well, look again”. Seriously, take a second look. With how interconnected and advanced the world is right now, there is always an asset in your grasp. It may not necessarily seem obvious, but it’s definitely there. It may be something as simple as following your passions for baking and selling to friends and family. Or if you like helping people and have an knack for organization, look into becoming a wedding planner. Whatever your interests, hobbies, or unique skillsets are, there is where you may find the best asset you could hope for.
