Introduction to Assets, Liabilities, and Equity

What are these words, and what do they share in common?  Well, as we begin to understand the financial terms used each day, and how they interrelate to each other, these three words are going to be key players.  Almost every possession we ever acquire, personal or business, will consist of an asset value, a liability value, and the equity we have in the possession.

The term asset refers to something that is of value to use.  Our education is an asset, albeit and intangible one, it is an asset.  Our cars are assets, and this would be a tangible asset that we can actually see and touch.  Do we owe for our car?  If so, the loan associated with our car is a liability.  The difference between the asset value and the liability value of the loan is our equity in the car.  This is as brief a summation of these terms, however these terms do need some further explanation and exploration.

An asset.  So many things that come into our lives will be classified as assets. Our homes, our cars, our education, our possessions, they will all constitute our assets.  We don't often think of them in these terms.  Quite honestly, assets and liabilities are generally used only by business people and accountants.  In reality however, we should really have a grasp on what our assets are, and what they can mean to us, financially.

For instance, your education is an asset.  It is known as an intangible asset, because you can't actually see your education.  It is an asset nonetheless because it gives you increased knowledge of a specific subject.  You are able to turn this education into a greater income than the individual without an education.

What is the term liability going to refer to?  Liability is a debt we owe, we incur, or are otherwise responsible for repaying.  Why do we have liabilities?  If you borrow money to purchase a car, the loan is a liability.  If you borrow money to go to school and get a higher education, the student loan is a liability.  We incur these debts because we want things we cannot afford to pay for in full when we need to purchase the asset.

What if, when you borrow the money to buy a car, the amount you borrow is less than the value of the car?  Then you have established equity in the car.  When you assess the monetary value of an asset, you consider the difference between the monetary value and the amount owed against the asset as equity.  The more equity you can establish with your assets, the more comfortable your life becomes.  This is why we strive for adequate cash assets when we begin to reach retirement age.

Often we allow our wants and desires to overtake our financial ability to repay, and we discover we must declare bankruptcy, or we cannot repay our obligations.  The best way to avoid this situation is to have a clear, rationale picture of your finances at all times.

Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.