Assets, Liabilites, and the Difference They Make

22 May 2012

Heraclitus was suspicious of rivers. They may look the same from moment to moment, but, as he famously said, you could never step in the same one twice. Of course, rivers are not the only thing in flux. If he were around today, the philosopher might also cast a wary eye at your balance sheet. That document reflects the financial state of your business at a selected point in the past, but, in truth, your bottom line changes constantly due to the interaction of your assets and liabilities. The two may come together to form an unstoppable current, but by learning the difference between these terms and understanding how they affect your business, you can at least ensure that your finances are flowing in the right direction.

An asset is anything your business owns that will allow you to produce value. This includes items you can see or touch, such as your tools, your shop, and the goods you sell as well as less tangible items such as intellectual property or a solid brand identity. The power of assets is quite exciting. Not only do they expand your capacity to generate revenue, but they also increase your potential reward should you ever decide to sell the business and move on to another venture.

Liabilities have precisely the opposite effect. Essentially, any obligation your business has to pay a creditor or compensate another party due to past decisions is a liability. This would include such items as wages owed to workers, the balance you owe on outstanding contracts, and costs associated with maintaining your equipment. While unavoidable, liabilities should be minimized and tightly controlled because they shrink your business’s profits, capacity for growth, and overall valuation. Why? Because the only way to pay off a liability is to give away a portion of your assets.

The principle of minimizing liabilities and acquiring  assets is vividly illustrated in Rich Dad, Poor Dad, Robert T. Kiyosaki’s personal finance classic. While Kiyosaki discusses individual money management, his idea is equally applicable to business: The rich get richer because they avoid liabilities and use their disposable income to obtain assets. Like the Rich Dad described in the book, your business can prosper if it directs the flow of its income towards procuring assets. Unfortunately, it is equally possible for a business to emulate Poor Dad, becoming so mired in liabilities that obtaining new assets becomes almost impossible.

The solution, of course, is to ask yourself if your business will be obtaining an asset or a liability as the result of each decision you make. If it the answer is an asset, strongly consider going ahead. If the answer is a liability, tread carefully. No decision is neutral; the river always changes. Success lies in knowing which direction the current flows.

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