Knowing your assets and liabilities is key to knowing your financial standing. It will help measure your financial stability and it is a good way to gauge whether you’re in a position to make better financial decisions in your life.
Getting a clear picture of your total assets and liabilities allows you to know your financial net worth, which is a figure determined after deducting all liabilities from all of your assets.
You can improve your financial position by decreasing your liabilities, increasing your assets, or both.
Knowing your assets and liabilities is important for two reasons:
- It is required when you file your yearly income tax.
- You need it when you’re applying for jobs where financial transparency is a prerequisite, like the Philippine Civil Service or the banking and financial services industry.
Knowing your net worth can also improve your financial standing, allowing you to set purpose-based or time-based financial goals.
So, understanding your assets and abilities and practicing sound financial habits will help you become financially wise. This will empower you to manage your expenses well to avoid financial distress, prepare for future needs, or allow you to invest in a basic portfolio of financial products.
What are assets?
Let’s start with the basics. Assets are classified as anything of value or a resource of value that you own that can be convertible to cash. Individuals, companies, and even the government can own assets.
Personal assets are things of current or future value which are owned by an individual or a single household. Some examples of personal assets are:
- Cash, certificates of deposit, savings accounts, Treasury bills
- Property or land as well as any physical structure that is built on it
- Personal property like jewelry, cars, and other vehicles you own
- Investments like bonds, the cash value of life insurance policies, mutual funds, stocks
There are several types of assets you can have.
Based on convertibility
Current assets. Current assets, as the name suggests, are assets that can readily be converted into cash and cash equivalents (typically within a year). Current assets are sometimes also called liquid assets. Examples of these include cash, accounts receivables, and inventory.
Fixed or Non-Current Assets. Non-current assets, on the other hand, cannot readily be converted into cash and cash equivalents. These can also be called fixed assets, long-term assets, or hard assets. Some forms of non-current assets are land, machinery, and trademarks.
Based on physical existence
Tangible assets. When judging assets based on their physical existence, we can classify them as tangible assets if we can touch, feel, see, or hold them. Lots, houses, and cars are just some kinds of tangible assets.
Intangible assets. Unlike tangible assets, intangible assets do not have physical characteristics. These include goodwill, patent, and copyright.
Based on usage
Operating assets. Operating assets refers to assets which are needed in order to operate a business. These are used to generate revenue like inventory, a warehouse, and patents.
Non-operating assets. Non-operating assets, also called redundant assets, are assets that are not directly required in the business operations but still provide the business with revenue such as underutilized cash, marketable securities, and loans receivable.
What are liabilities?
Liabilities, on the other hand, refers to something a person or corporation owes (such as money) to another person or corporation.
Examples of liabilities include:
- A home mortgage loan
- Any other type of contracted loan, whether it’s for your car, your business, or a significant expense, such as school tuition
- Credit card bills
- Utility costs, whether commercial or residential
- Wages and allowances
- Yearly income, real estate, and business tax payments.
How are assets and liabilities connected?
Often when you acquire an asset, you also create liabilities.
For instance, you purchase a Toyota Vios worth P1 million. This gives you an asset worth PHP 1 million. But in order to purchase it, you need to take out an auto loan from your bank also worth PHP 1 million, giving you a liability which costs the same amount.
If your asset and your liability equate to zero, then what’s the point of acquiring assets? Because assets show you your owner’s equity, which is your net worth.
So Owner’s Equity (or net worth) = Assets - Liabilities.
Managing your liabilities
Having liabilities is an inevitable part of acquiring assets. Learning how to manage your liabilities plays a crucial role in how you plan your asset or wealth building. If you’re not careful, your liabilities can outweigh your assets, causing you to fall into debt.
In order to manage your liabilities, you should:
- Establish your payment sources.
- Pay your liabilities (such as rent, credit card bills, and loans) on time.
- Create a monthly bill payment calendar for when to pay your liabilities.
- Set a timeline on when to complete payment for your liabilities.
- Periodically check your progress to ensure you are following your timeline through.
A complete financial picture
Calculating the value of your assets and liabilities is a calculation that represents all your assets at a specific point in time. What you are worth one year will differ compared to the years that follow. Think of it as your yearly health check. You need to do it regularly to examine if your systems (assets and liabilities) are in order. While knowing your net worth may not change it, it can give you a better idea of things that you can and should change in order to reach your financial goals.
If you would like to learn more about assets and liabilities, head over to this article we wrote on limiting your liabilities.
