A Simple Guide to differentiating Assets from Liabilities

A simple measure of wealth is the difference between one’s assets and liabilities. In other words, what you have left after settling all your debt obligations is what your fortune is.

This means growing your assets faster than your liabilities can improve your fortune the same way reducing your liabilities without depleting existing assets can.

Although this sounds straightforward and perhaps simple, distinguishing assets from liabilities can be tricky.

Is a car an asset or a liability? How would you classify an expensive artwork in your house? How about a mortgage?

Here is a basic way to draw a parallel between assets and liabilities.

 

Cash Cow or Cash Out

A cash cow in this instance is not the business unit generating higher-than-market returns. It is that particular property (tangible or otherwise) that helps you make money.

By the same token, a cash-out (not same as profit-taking) costs you money.

This definition was popularized by Robert Kiyosaki, the author of Rich Dad, Poor Dad, although he did not use either term.

According to Kiyosaki a BMW that loses few thousands every time you drive it would be a liability ( in strictly financial terms, although you may drive non-monetary benefits like pleasure from riding one). In the same vein, the same car used for Uber Services would be an asset (so far it is generating more cash than it costs you to maintain).

You can use the same parameter to gauge other things like your rent which would be a liability in every sense since it is a one-sided flow of cash.

There is a caveat however that a property said to be a liability in the short run can become an asset over time.

A mortgage is a classic example; in the immediate period a mortgage, which is a home loan with the house as collateral, is a liability in the short term but once repayment is complete, it becomes an asset

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Another way is to classify assets as whatever saves you money; not everything you own would bring cash (at least immediately) but they can help reduce your or reduces your liability in the immediate period or the future.

This is not a popular definition but it is broader in the sense that expenditure on things like education, nutrition and fitness and the likes can be categorized.

This perspective according to some financial experts is also necessary because it would help you avoid a short-term view of building wealth and ensures sustainability.

In summary, identifying what brings more money than it takes from you, and vice versa is a simple way to distinguish between assets and liabilities.

This is a very subjective definition if you want to point out specific items like cars, houses, artworks and the likes, but it is, in fact, a good approach because the same item may serve a different purpose to different people.