Bookkeeping basics: assets and liabilities, explained
There are things we just know. For example, the sun rises in the east, George Washington is on the $1 bill, and you didn’t start your business to manage the books. That is, unless that business happens to be an accounting firm.
Still, one of the first realities new entrepreneurs face is that running a business is more than just following their passion and serving their customers. It also entails the less glamorous task of handling finances, creating reports, and keeping track of assets and liabilities on a balance sheet.
The problem is that if—like most small business owners—you’re not a finance professional, you may be a little vague on the money-related details.
First, the basics: What’s a balance sheet?
A balance sheet is a financial statement businesses are required to file, typically once every quarter. It provides a quick view of a business’s financial situation by listing its assets and liabilities, two of the most fundamental indicators of a business’s financial health.
Assets are anything the business owns that can produce future economic benefits. Liabilities, on the other hand, are anything a business owes. This could be money, equipment, or services. Simply put, a successful company has more assets than liabilities.
A correctly filled balance sheet allows owners, bookkeepers, stakeholders, and auditors to quickly assess a company’s past, current, and future equity. In other words, it makes it easy to calculate how much money the business is worth by using the common equation:
Total Assets – Total Liabilities = Equity
So, what are assets?
In short, anything your business owns that has monetary value is considered an asset. The two main types of assets are tangible and intangible.
Physical or quantifiable objects with a clear financial value are considered tangible assets. They go on your balance sheet and are divided into two main categories: current assets and non-current assets.
Anything tangible that a company expects to turn into cash within a 12-month period is considered a current asset.
Examples of current assets include:
- Physical cash
- Money in the company’s checking account
- Raw materials
- Accounts receivable (AR)
- Signed contracts for future short-term projects
Tangible assets owned by a company that are not expected to be turned into cash within a year are non-current assets. In other words, these are long-term investments that are not directly meant to produce profit any time soon.
Examples of non-current assets include:
- Real estate, assuming your business is not selling or renting it out: offices, stores, land, or factories
- Company vehicles
- Equipment and machinery
- Office furniture
- Stocks and bonds
Assets that are not physical objects you can touch or count are considered intangible assets. While they have monetary value, which affects the company’s worth, it is often difficult to quantify.
For this reason, they are typically not included in the balance sheet, especially for small businesses.
Examples of intangible assets include:
- Business reputation
- Logo and brand
- Customer lists
- Partner networks
Are consumables assets?
We’ve already established that things owned by a business are considered assets, but that doesn’t mean everything in your office should be listed as one. A good rule of thumb is that if something cannot be sold or otherwise realistically liquidated and turned to cash, it shouldn’t be listed as an asset on your balance sheet.
So, if you happen to sell coffee beans for a living, go ahead and list them as inventory, which is definitely an asset. But, if you just have a two-pound bag of beans for your morning brew, we suggest you leave it out of your balance sheet.
What are liabilities, then?
Liabilities are everything a business owes, whether it’s money, labor, or goods. All liabilities must be included in the balance sheet and divided into two main categories: current and non-current liabilities.
Any debt a company intends to clear within the next 12 months is listed under current liabilities.
Examples of current liabilities include:
- Outstanding bills, aka accounts payable (AP)
- Accrued expenses
- Deferred income, in other words, goods or services already paid for but not yet delivered
- Current portion of long-term debt
- Employee salaries
Any debt that will not be covered within a year is a non-current liability.
Examples of non-current liabilities include:
- Long-term lease obligations
- Long-term loans
- Commercial mortgage
- Non-current accrued expenses
- Non-accrued expenses
How this applies to a small business like yours
Every business, regardless of size, has both assets and liabilities that must be listed and reported. Still, they vary according to industry, business type, and stage of growth.
To help illustrate what this looks like, here are a few examples of businesses and what some of their assets and liabilities are likely to be. For simplicity and clarity, we only covered assets and liabilities that need to go on a balance sheet, leaving out intangible assets.
A corner pizzeria’s assets and liabilities
Current assets: ingredients to make 1,200 pizzas, soft drinks inventory, 12 wine cases, 5 beer kegs, cash in the register, an unpaid invoice for 50 pizzas sold to a local business customer (net 30 terms), 1,500 pizza boxes, and daily fresh toppings deliveries, paid through until the end of the quarter.
Non-current assets: two stone ovens, a 250 square feet restaurant space with a storefront, kitchen equipment, utensils, 6 dining tables, 18 chairs, a commercial dishwasher, and two delivery scooters.
Current liabilities: an unpaid bill for sauce, mozzarella, and vegan cheese, this month’s payroll for a staff of six, sales and employment taxes not yet remitted, an invoice for oven repair, and a bill for a new website design.
Non-current liabilities: commercial mortgage on the restaurant space, a 36-month loan to purchase an additional scooter, liquor license fee.
A freelance web designer’s assets and liabilities
Current assets: money in a checking account, undeposited checks for a recent website designed for the corner pizzeria, and payments due from three other customers.
Non-current assets: a laptop, a stylus pen, a professional tablet, two large screens, an ergonomic mouse and keyboard set, an adjustable standing desk, and a cell phone.
Current liabilities: internet, phone, and electric bills, taxes collected but not yet remitted, and a bill for professional tax filing by an accountant.
Non-current liabilities: 18-month financing plan for a new laptop, a $20,000 loan taken out to start the business.
A home renovation business’s assets and liabilities
Current assets: lumber, construction equipment, painting supplies, two signed contracts for building backyard decks, and 10 uncashed checks from customers amounting to $95,000.
Non-current assets: three company vans, two laptops, four walkie-talkies, a five-year contract with a local school for maintenance services.
Current liabilities: payroll and taxes for four employees, rent for office and storage space, a bill for repairing a flat tire on one of the vans, and business and third-party insurance.
Non-current liabilities: long-term credit used to buy equipment and supplies in bulk and 24 payments left on a used-van purchase.
It’s time to balance that sheet
Even if you have an accountant who does the heavy lifting for you, knowing how to prepare a balance sheet is a valuable skill for your business and for you as an entrepreneur. It gives you a better picture of where your business stands and its most pressing challenges. It can also help you figure out where to invest more and where to downsize.
Now that you have a better idea of what assets and liabilities are, you can start creating balance sheets to get a better perspective on your business.
And, if you need a simple tool to manage your incoming and outgoing payments, you can simply sign up for Melio today. It’s free.