What is Asset Liability and Owner Equity?
Asset vs Liability vs Owner Equity. Do you know what each of these stand for? In our goal of financial freedom, the earlier we come to understand this, the faster we will start the journey to reach our goal of financial independence retire early (fire). We at Your Rich Freedom, keep stressing the importance of investing in assets to generate passive income. I am sure you must have come across this many times. In today’s article, we aim to help you understand What is Asset Liability and Owner Equity in personal finance. Let us begin.
P.S. In our article titled Top 3 Best Personal Finance Books for 2021, we recommend reading three books that can help you understand more about how you can achieve your goal. They also highlight and explain more about assets liabilities.
What is an Asset?
In simple words, anything that puts money in your pockets is an asset.
For example, Do you own an apartment? Does it bring money into your pockets at the end of the month? If you are using it for your personal purposes, then, you are obviously spending money from your pockets. You may spend it on repairs, association maintenance fees, cleaning, insurance, electricity, perhaps even a mortgage. This is nothing but a liability because it takes money out of your pockets.
But what if you had given this apartment on rent?. You would have received rent every month. Will it bring money into your pockets every month?. Imagine also that the rent received is more than the costs which you may incur. Will it be profitable? Since it brings net cash to your pockets, it is an asset.
More examples of assets can be your business, your blog (if you are a publisher), your camera (if you make money clicking pictures), your laptop (if you use it to write for your blogs), your youtube channel (if you make monetized videos).
In a business, assets are any resources owned by a business that can be used to produce a value that can aid in generating income. For example, imagine you own a furniture shop. Your furniture shop will have a stock of furniture. This stock of furniture is produced from assets owned by your business. These assets can be sold to generate income. I hope you got our point.
What is a Liability?
In simple words, anything that takes money out of your pockets is a liability.
For example, Do you own a car? Does it bring money into your pockets at the end of the month? If you are using it for your personal purposes, then, you are obviously spending money from your pockets. You may spend it on repairs, maintenance, cleaning, servicing, and insurance. This is nothing but a liability.
But imagine, you had given this car for rent. Then, will the car bring money to your pockets every month?. Imagine also that the rent received is more than the above costs which you may incur. Will it not be profitable? Since it brings net cash to your pockets, it is an asset.
In a business, liability can be a bank loan, taxes, and even salaries, etc. What I have observed in my consulting is whenever we are preparing to file the tax returns, some of our clients become very interested to understand all these terms, but as soon as we file it, we do not hear from them till next year. And the circle of questions keeps repeating themselves.
More examples of liability include buying every latest mobile release(if it does not help you in any way other than calling), a second car (if you are the only one driving in your household). Remember you do not have to keep up with the Kardashians. You just have to live a life that makes you happy! For me, happiness is being free to do what I want with my time without any worry.
What is Owner Equity?
In simple words, it is the money invested in an asset.
For example, Did you buy a new house? Imagine you paid 40% of the house price from your own funds and the balance 60% through a bank loan. How much equity do you have in the house? Any guesses? If you have guessed 40%, you are right.
Another example of equity is when you buy equity shares of a company, you have ownership rights to the company. When you and your friend start a business, you and your friend have equity in the company, meaning ownership in the company. I hope you got it.
Equity is measured by ‘the value of the assets’ minus the ‘the liabilities associated with the assets’.
In the goal of Financial Independence Retire Early, we focus on building as many assets as possible that can generate passive income. If the monthly passive income generated from these assets is more than your monthly expenses, then, I can say you did it, your rich freedom.
Hope this article has helped you in understanding the difference between an asset, liability, and equity. What are some unique examples of assets, liabilities, and equity that you all can think of? We would love to know in the comments.
If you also have any questions or any areas of personal finance where we can help you understand better, do not hesitate to let us know in the comments below and we will get back to you quickly.