What is an asset?
An asset refers to any resource that a company owns or controls and that can be used to generate economic value. These resources can take many forms, including physical objects like buildings, land, machinery, and equipment, as well as intangible items like patents, copyrights, trademarks, and goodwill.
Assets are essential to a company’s operations because they enable the business to produce goods and services efficiently and effectively. For example, a manufacturing company may own a factory that houses production equipment, raw materials, and finished products. This factory is considered an asset because it enables the company to produce and sell goods.
Assets can be categorized into two main types: current assets and fixed assets. Current assets are those that are expected to be converted into cash within one year, such as inventory, accounts receivable, and cash on hand. Fixed assets, on the other hand, are those that are expected to provide long-term benefits to the company, such as buildings, land, and equipment.
Assets are recorded on a company’s balance sheet, which is a financial statement that provides an overview of the company’s assets, liabilities, and equity at a particular point in time. The balance sheet is an important tool for investors and creditors to assess a company’s financial health and stability.
What is Equity?
Equity refers to the portion of a company’s assets that is owned by shareholders. Equity represents the residual interest in the assets of the company after all liabilities have been paid. In other words, equity is what is left over for shareholders if the company were to sell all of its assets and pay off all of its debts.
Equity can take several forms, including common stock, preferred stock, and retained earnings. Common stock represents the ownership interest that shareholders have in a company and gives them the right to vote on important corporate matters, such as electing the board of directors. Preferred stock, on the other hand, typically has priority over common stock in terms of dividends and liquidation preferences. Retained earnings are profits that a company has earned but has chosen to keep rather than distribute to shareholders as dividends.
Equity is important for a company because it represents the value that shareholders have contributed to the business. When a company issues stock to raise capital, it is essentially selling ownership in the company in exchange for cash. This cash can then be used to fund operations, invest in new projects, or pay down debt. As the company grows and becomes more profitable, the value of its equity can increase, which can benefit shareholders through higher stock prices and dividend payouts.
Equity is recorded on a company’s balance sheet as part of the owner’s equity section. The owner’s equity section also includes other items, such as retained earnings and treasury stock (which is stock that the company has repurchased from shareholders). The owner’s equity section is an important component of the balance sheet because it provides a snapshot of the company’s financial position at a particular point in time.
This is the basic accounting formula:
Asset = Equity + Liability
- Asset is the value of your stuff
- Equity is the part you own
- Liability is the part you owe
The reasoning behind this formula is that there are only two sources of finance for an entity. Either equity or liability. To increase funds of a company it would either obtain a loan or its owners would contribute funds ( or it can be through profits which also increase equity). There are no other possible ways.
Therefore any assets that a company has would have been obtained from one of these two sources either equity or liability. So, an increase in assets must be through an increase of one of these source of finance.
Similarly, if there is a decrease in company’s assets, that indicates either a decrease in liability i.e. repayment of loan; or a decrease in equity which can be either a loss borne by the owners or distributions to them. There is no other way assets of a company can reduce.
Double entry accounting usually reports assets as the left “assets” side of a balance sheet, while debt and equity make up the right “liabilities” side of a balance sheet. Equity is a “liability” to extent it is not an asset of the corporation, rather is owned by its shareholders.
- Ownership: Assets represent what a company owns, while equity represents what the owners of the company own.
- Source of funds: Assets are purchased using funds provided by the company’s owners or through borrowing, while equity represents the owners’ investment in the company.
- Position on the balance sheet: Assets are listed on the left-hand side of the balance sheet, while equity is listed on the right-hand side.
- Liquidity: Assets are generally more liquid than equity. This means that assets can be easily converted into cash, while equity cannot.
- Value: Assets are valued based on their purchase price or current market value, while equity is valued based on the company’s net worth.
- Ownership rights: Equity holders have ownership rights, such as the right to vote on company matters and the right to receive dividends, while asset holders do not.
- Risk: Equity is riskier than assets, as equity holders are the last to be paid in the event of bankruptcy or liquidation.
- Return on investment: Assets generally provide a lower return on investment than equity, as they are less risky.
- Time horizon: Assets are generally held for the short-term, while equity is held for the long-term.
- Flexibility: Assets can be sold or traded more easily than equity, as ownership of equity is tied to ownership of the company itself.
Equity vs Assets In Tabular Form
In general, we use the term “equity” when the organization has owners. Every corporation has owners, so using shareholders’ equity or just equity is appropriate when we refer to a corporation. Same idea goes for sole proprietorships and partnership. In other words, Equity is the shareholders capital invested in the Company and is part of total liability of the Company.
Assets are of various types like fixed assets which include plant, land, building etc, current assets would include loans, advances, stocks, securities, cash, bank balances etc., intangible assets like goidwill, patents, rights, etc, Any thing which is owned by the Company for which a value may be raised by the Company is the Asset of the Company.