For reporting the financial health of a business, few reports are as essential as the balance sheet. Since balance sheets are often used to assess how a company operates compared with others or with its own past periods, accountants prepare balance sheets using generally accepted procedures. Business assets are usually reported by account classifications in order of liquidity, beginning with cash.
Simply defined, assets are things that a business owns. These things have an immediate or future dollar value to a company, and accounting practices take into account this immediacy when listing assets. Common assets can include:
- cash in bank accounts
- petty cash
- real estate and buildings
Less obvious things also qualify as assets. Some of these may include prepaid expenses that haven't been used up yet, such as advertising and insurance, the amount of a business sale price above its tangible assets, called goodwill, and land improvements.
The Importance of Liquidity
Some of a company's assets are cash or things that can be converted to cash quickly. This gives assets priority when being classified on a balance sheet, since converting assets to cash may be a priority with lenders or potential buyers. The ability to convert assets to cash is called liquidity and it's measured roughly in units of time. Those assets that convert quickly into cash, usually within one year of the balance sheet's creation, are called current assets.
Order of Liquidity
Balance sheets list assets in order of liquidity. Cash tops the list, since it requires no conversion. Stocks and other investments that can be sold in a few days are usually next. Money owed to the business through normal sales is considered by the company's sales terms, so receivables may have a 30- or 60-day liquidity, for example.
Inventory might take a month or two to be converted through turnover and sales. In some cases, inventory may be resold quickly, so its place in the order of liquidity may vary by company.
Fixed assets, such as equipment, require a market for selling, and so usually rank lower on a balance sheet, and goodwill is only realized upon sale of the business. It is listed near the bottom for that reason.
Asset Account Classifications
While liquidity plays a large role in defining the correct order of assets on a balance sheet, the flexible nature of liquidity demonstrates the need for standard classifications to provide direct comparisons. Asset classifications on a balance sheet are normally ordered as:
- current assets
- property, plant and equipment
- intangible assets, such as patents, trademarks and goodwill
- other assets, such as bond issue costs