What are assets and liabilities intelligibly: from A to Z
Many are thinking about creating sources of passive income in order to live carefree on this income. Get rid of the need to go to work and do only things you love. And someone even wants to travel around the world. Get a lot of positive and unforgettable impressions. Beginning their journey of creating passive income streams, beginners often acquire assets that actually turn out to be liabilities. So what are assets and liabilities in simple terms? How to create good assets and avoid liabilities? Let’s figure it out.
Many people want to achieve financial prosperity in their lives. Like any other concept, financial well-being has several levels. When we create assets, they help us achieve a certain level of income. Passives, on the contrary, slow down our movement towards the goal.
Financial well-being can be divided into 3 conditional levels.
Financial freedom – at this level, you can no longer worry about spending on basic needs. Such as accommodation, meals and so on. Additional sources of income and assets provide coverage for these costs. But we are still dependent on the main source of income. That is, works, in most cases.
Financial security – allows us to feel already more secure and free in relation to the main source of income. His loss, in which case, will not be a critical and tragic event for the family or personal budget. After all, the assets we have fully cover the monthly family or personal expenses.
Financial independence – at this level, we no longer need to go to work every day. You can completely immerse yourself in your favorite pastime and not think about your daily bread. You can travel anywhere and anytime. The income from our assets allows all this and ensures the growth of our wealth.
life is Beautiful
The better we understand the value of assets and the essence of liabilities, as well as the opportunities they bring to us, the easier and faster the path to financial well-being and prosperity will be.
What are assets and liabilities in simple words
Let’s look at what assets are and how they differ from liabilities. And most importantly, we will understand whether all assets are equally useful, and liabilities are equally harmful.
There are several approaches to defining assets. One definition has to do with accounting, which refers to assets as anything that can generate a profit. For example, an enterprise has an office building, it will be classified as an asset, since it can be sold and received money for it.
For the purposes of personal and family budget management, we suggest using the approach of Robert Kiyosaki, which he described in his book Rich Dad Poor Dad, when determining assets.
An asset is all our property, property and financial instruments that bring money to your budget on an ongoing basis.
With this approach, our apartment, which we own and rent, is an asset, as it brings money into your pocket. Or the portfolio of dividend stocks on which we receive payments is also an asset. Or the cashback services through which we make purchases also belong to the asset.
Read more about how to make money on cashback programs in the article (the link will open in a new window).
An asset can be good or bad. Let’s look at examples:
- We are renting out our apartment. The tenant pays 20’000.00 🪙 per month. The operating costs for the apartment are 5’000.00 🪙 per month (communal, insurance, tax, etc.). This is a good asset, as it provides an inflow of money (or a positive balance – the difference between income and expenses) to the family budget.
- We are renting out our apartment. The tenant pays 20’000.00 🪙 per month. Operating expenses for the apartment 25’000.00 🪙 per month (mortgage, utilities, insurance, tax, etc.). This is already a bad asset, as it provides an outflow of money (or a negative balance) from the family budget.
This approach is applicable to other assets as well. Think carefully, are all your assets good or is there something to work on?
Liability is all our property, property and financial instruments that take money from your budget.
With this approach, our apartment, which we own and live in, is a liability, as it requires money for its maintenance.
The passive can also be good and bad. Let’s look at examples:
- We decided to take out a consumer loan for a vacation or to buy a new TV. This loan is our liability, and a bad one, as it requires additional money from our budget to service it.
- We took out a car loan to buy a car in order to earn money on it. Either as a taxi or rent, other options are possible. A car loan is a liability, though already a good one. Since it is supported by the income received from using the car as a taxi, plus additional funds also come to the family or personal budget if the process is properly organized.
The language of financial literacy
To be financially successful, you need to know the language of finance and communicate as often as possible. You must understand its basic terms, especially if they can be applied in your field of activity. At least when managing a personal and family budget.
Read more about how to keep a family budget in the article (opens in a new window).
The concepts of Assets and Liabilities are only a small part of financial terms. Let’s look at a few more financial concepts.
Income is the money that we, as well as our family members, if any, receive for our work and knowledge. In this article, we will have in mind exactly money, since income can be, both in the form of any items, and not material. For example, we rendered a service to someone, and we were given a mobile phone as a gift. We can now sell it and get money.
Thus, income is all the money that comes to us from our activities and assets.
Income is good and bad. This division is not related to their size 😉
Good and bad income is determined by the ratio of the profit we receive to the time we spend on it.
time is money
For example, we rented an apartment for 11 months for 20’000.00 🪙 per month, the net profit will be 15’000.00 🪙. To pass it, we held 20 shows, each of which took 3 hours of time, taking into account the road. Now every month we will visit tenants to check the condition of the apartment and spend 2 hours on this, taking into account the road. As a result, an hour of our time spent on generating income will be worth 2062.5 🪙.
(15000 11)/(20*3+10 2)=2062.5
Now let’s calculate the cost of our time at work. Let’s say we get 80’000.00 🪙 on hand, we work 16 days a month for 8 hours. Then the cost of an hour of our time will be 625 🪙.
And if you add more travel time to and from work and a full working month of 20 days. The numbers will be even smaller. You can do this calculation yourself.
So which activity is more profitable in terms of the value of your time?
Expenses are our daily needs on which we spend our money.
Like assets, expenses can also be good and bad. As you may have guessed, this is also not related to the amount of spending.
Of course, not all expenses qualify for this classification, as without some of them we will not be able to survive.
Buying food is a necessary expense. Buying a cell phone of the latest model is a bad expense. Especially if we do this every time a new phone model comes out. Paying for training, such as programming, is a good expense. Provided that we will earn money with the acquired knowledge.
Another term to understand and apply in your life is delayed gratification. This concept characterizes the ability of a person to sacrifice a momentary benefit in order to obtain a more significant benefit in the future.
For example, we invested part of the money in the shares of a company that we thoroughly studied before buying. And at the first drawdown of the market, we are not in a hurry to get rid of them, but we are waiting for the achievement of our goals for these shares. Plus, we will still receive dividends.
Another good example of this term would be the habit of taking care of your retirement benefits from a young age. If at the age of 20 you start investing 10’000.00 🪙 per month in a life insurance program, which also brings an annual income, let’s say 5%. Then by the age of 60 we will have a capital of more than 15’000’000.00 🪙. Good reward, right?
This term is closely related to the concept of deferred gratification. After all, for compound interest to work more efficiently, it takes time.
In the banking sector, the concept of compound interest is also known as capitalization on a deposit.
It works like this: we get a certain percentage every month on the invested money. The amount of interest paid is added to the principal amount of the deposit. In the next month, interest is charged on the entire amount of the deposit, taking into account the interest paid. And so on until the expiration date of the deposit.
Let’s look at an example. Let’s say we deposited 100’000.00 🪙 at 5% per annum. In the first month, we will receive interest in the amount of 416.67 🪙. In total, at the end of the month, the account will have 100’416.67 🪙. Next month we will get 418.4 🪙, the account will have 100’835.07 🪙. If the deposit is open for 1 year, then at the end of the term we will receive 105’116.19 🪙. Against 100’500.00 🪙 on a regular deposit, the interest on which is paid at the end of the deposit term. In other words, we will receive an additional 2.3% to profit.
Let’s look at the effect of compound interest in solving specific financial problems.
Task 1: How long will it take to reach the financial goal?
Suppose we need to accumulate 10’000’000.00 🪙 for some purchase. Let the interest rate on the deposit be 5%, only in one bank the interest is charged monthly, and at the other end of each year. So how long will it take to accumulate the required amount, assuming that we deposit 10’000.00 🪙 every month into the account?
|Contribution||Payment per month||Deposit rate||Required amount||Accumulation period|
|with capitalization||10’000.00||5%||10’000’000.00||32.9 years|
|without capitalization||10’000.00||5%||10’000’000.00||80.6 years|
As you can see, in the first bank we need 2.4 times less time to collect the required amount. And this is all due to the effect of compound interest. Calculation table
Challenge 2: How much money do you need to save each month to reach your financial goal?
Let’s say we want to have 50’000’000.00 🪙 savings for retirement. In one case we have 40 years to save, in the other we have only 20 years. So how much do you need to set aside each month to reach your goal? For simplicity, the investment return is defined as 8% over the entire period.
|Accumulation period||Rate of return||Required amount||Monthly payment|
As you can see, in the first case, the accumulation period is 2 times longer, but at the same time, 5.9 times less money is required to achieve its goal every month. Accordingly, the impact on the family budget in the first case will also be less. Table with the calculation.
It must be remembered that the effectiveness of compound interest depends on time, the size of the percentage of profitability and the frequency of investments.
A financially literate person knows his profitability. Simply put, he knows how much he pays for himself. Personal profitability is calculated by the formula:
(earned income – living expenses) / living expenses × 100%
Let’s take two people as an example. Peter is a sales manager in a commercial organization. He is well settled and earns 100’000.00 🪙 per month. At the same time, his expenses are 80’000.00 🪙, since he must correspond to his status. His friend Denis is a simple administrator. He earns 60’000.00 🪙 and spends only 40’000.00 🪙 per month.
At the first approximation, Peter earns more. But in reality, the situation is radically opposite, if we calculate the profitability of their work. So the profitability of Peter’s labor is 25% versus 50% for Denis.
This means that every 🪙 that Denis spends to provide for his life brings him 50 kopecks. While Peter receives only 25 kopecks from his expenses. And which of them lives “more effectively"? Looks like Peter is not so lucky…
Read more about financial literacy in the article, opens in a new window.
Dotting the Yo
Develop financial literacy in yourself to achieve financial well-being. One of the components of financial wealth is an accurate understanding of what of your property or property is an asset and what is a liability.
As already mentioned, assets are, first of all, all our property and financial instruments that should bring us income. From this point of view, it is necessary to invest money in tangible and intangible objects.
So what kind of property is considered an asset and what is not? As we wrote earlier, the main criterion for such a division will be the fact of receipt of income in the personal or family budget.
An example of the division of property into categories of assets and liabilities is presented in the table.
|Own apartment for living||YES|
|Own apartment for rent||YES|
|Own garage for car storage||YES|
|Own garage for rent||YES|
|Auto for own use||YES|
|Own taxi car||YES|
Yes, you can earn income by selling an apartment, however, it will be a one-time income. And there is no need to talk about a permanent income, and even in a passive mode. In addition, you will also be left without an apartment after its sale. Where to live? If this is the only apartment, then there may be expenses for renting an apartment. The apartment in which you live is a liability, as it constantly consumes money in the form of utility bills and capital repairs. And someone else and pay the mortgage and insurance.
Whether this sale will bring income to the family budget is another question. Since the amount of income will depend on the economic situation in the country (when selling during a crisis period, the cost will be lower), on the costs that you incurred to purchase and maintain an apartment. You also need to take into account the period of ownership of the apartment, as it may be necessary to pay tax.
The same situation is with the rest of the property that you own. Conduct an analysis of your property and think about how to transfer, at least part of it, from the category of Liabilities to the category of Assets. Perhaps something better to sell or rent? Start earning on your property.
To achieve financial well-being, it is necessary to acquire more assets and fewer liabilities. At the same time, it is necessary to acquire good assets. And in some cases, liabilities, but only good ones.
For example, you can take training in interior design and landscape design. On the one hand, this is a liability, since you need to pay for tuition. But this is a good liability, because you can use the knowledge gained to organize additional income. You can provide planning services for summer cottages or apartment design, in your free time from your main job. At the same time, you can earn extra money on tuition fees if you pay for it with a cashback card. So on the Alfa Bank card you can get up to 2% cashback.
The concept of assets and liabilities is very well and intelligibly discussed in Robert Kiyosaki’s book "Rich Dad Poor Dad". We recommend reading it.
Look for opportunities to create Assets that generate passive income. These can be dividend stocks, and commercial real estate, and investments in rental funds, and much more.
We tried to explain in simple terms the value of assets and the essence of liabilities. Apply what you have learned in your daily life. Take advantage of opportunities that provide good liabilities and avoid bad assets.
Now you know what assets and liabilities are. In simple words, these are the sources of your financial well-being. Achieve financial freedom and be open to new things.