Know your liabilities

Khushbu Agarwal | Last updated: 16 December 2022

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Quick Summary

This article clarifies the distinction between assets and liabilities. Assets are items you own with exchange value that provide future benefits, like property or investments. Liabilities are future obligations you must meet, such as loans or debts. Understanding this difference is crucial for sound financial management, as it allows you to identify and potentially convert liabilities into assets.

Think of a situation where you "consider bad as good and good as bad." This same thing you do with your assets and liabilities…Getting my point or not?

Ok…… Let me elaborate on it more meaningfully.

First of all, let me explain to you what are assets and liabilities.

ASSETS

Assets are the things you own and have an exchange value (ie.you can sell them). These assets will provide you with future economic and financial benefits.

For example: your house, gold, desktop etc. which give you some value in future either in monetary or non-monetary form. Even any human being (here we can say an employee) is an asset of the company in which he works because he is giving his skills and time to achieve the goals of organisation and the organisation will get future benefits from him. One more example I can take here is, giving loan to someone is also an asset for you.

LIABILITIES

Liabilities are obligations that you have to meet in the future.

For Example: You borrowed 2000$ from your friend, then it's your liability or say obligation to pay the amount of 2000$ back to your friend. Another example is taking any loans, mortgages, taxes etc which you are obliged to pay.
Liabilities can be: -

Short term, i.e., for a short period of time say one year or less.
Long Term i.e., for a long period of time say more than one year
Contingent liability i.e., those liabilities that are paid only under some circumstances.

Now the question here arises is….How do you know or find that it is an asset or liability?

It's not always easy to tell whether something is an asset or a liability.. People who are lacking with proper financial knowledge might get confused easily.

Let's understand it with two basic real-life examples

1) Rasika is planning to purchase a house. But due to shortage of funds, she decided to go for home loan and purchased a house with that money and start her loan installments as EMIS to the bank. Now you say, is the house she purchased an asset or liability?

For our elder ones. a house is an important asset because it will be valuable and useful to you as it provides a roof for your family where you live and nurture your children. I'm not discouraging you from buying a house as a parent, a home is always a useful asset, but from a financial point of view, it is probably not an asset. You are paying off your loan, your house is an asset but not for you, it's an asset for bank. The bank will be generating money from your transactions. In simple words, money is left from your pocket and going to the pockets of the bank.

Some people think that a house is an investment because if you sell it, you make some money, but the point is if you own only one house and sell it and start living in a rented house then also it's like replacing one liability with another one. House maintenance and associated bills are also a big amount of liability.

2) Rasika is planning to purchase a car of Rs 16 lakh on loan. Now her EMIs and car maintenance are her major liability which she generated by purchasing a car.

Benefits of being financially literate

Now, if you ask me what to do in the above two situations…I have some recommendations which you will also agree with if you have financial literacy.

!) In the first case, If Rasika wants to convert her house liability into an asset, she can sell her house and invest the profits back in another property or she can earn rental income through house if she has more than one house. Then her house will be called an asset for her.

2) In the second scenario, Rasika must first determine whether she actually has the full sum of Rs. 16 lakh at this time or not. Will she be able to afford the car? She should wait till she has more money if the answer is no. Now, if she has Rs. 16 lakh on hand, she can invest that money in some safe assets and begin to produce returns. On the other hand, she can borrow money to buy a car, with the goal of paying back the loan via the returns she has already generated. It will result in better financial planning….

CONCLUSION

herefore, if maintaining the house costs money, the house is technically a burden for you. You must determine which of your holdings are assets, which are liabilities, and how to turn one into the other. Only with sound financial preparation and expertise is this possible.

The author can also be reached at agarwal.ka9081@gmail.com

FAQ :

An asset is something you own that has an exchange value and will provide future economic or financial benefits, such as a house, gold, or a desktop computer.

A liability is an obligation you must meet in the future, like repaying a loan, mortgage, or taxes. Liabilities can be short-term, long-term, or contingent.

From a purely financial perspective, a house purchased with a loan is an asset for the bank, not necessarily for you, as you are paying off the loan. Maintenance costs also add to its liability.

You can turn a liability into an asset by strategically managing it. For example, renting out a house you own can generate income, making it an asset. Alternatively, if you have the funds, investing in assets that generate returns can help you pay off liabilities.

Financial literacy is important because it helps you correctly identify your assets and liabilities, understand their financial implications, and make informed decisions to improve your financial position.