What Are Financial Assets? Overview, Importance, And More
Assets that can be utilized for the help of an organization, while having a good impact on the country’s economy, are the financial assets. In some ways, they’ve ensured our own technological advances or healthcare advance, as these economic resources and ownerships can be converted into cash. Read this article to know all about financial assets in detail.
What are Financial Assets?
Financial assets are liquid assets that gain value as per the ownership or contractual right associated with them. It is called a liquid asset because it can lose its value over time but can be sold easily. Stock equity, bank deposits, mutual funds, bonds, etc. can all be considered financial assets. These assets are often seen as financial instruments or securities, considering a company or business is considered financially stable if there are enough liquid assets.
Let’s understand it better
Assets are better categorized as real, financial, or intangible. They can also be physical assets, considered to be the ‘real’ asset, drawing value from the property. These could be physical objects like land, precious environment, real estate, rice, wheat, oil, iron, etc. The liquid assets can be used for the use and ownership of tangible assets. For legality, we can make legal contracts, and determine the value of areas that are likely to change at a predefined maturity value.
While intangible assets can be extremely important, there is no physical state or structure, only a statement. These can include patents, intellectual properties, and trademarks. Financial assets can be considered to be in-between other assets since they are seen as non-physical, only a statement/ value given on paper. But this paper can represent the ownership claim of a business, a company, a percentage of company shares, profits, etc. The market supply and demand will influence this value also.
Thus, financial assets are those that gain value from a contractual claim or ownership of an underlying asset. These underlying assets can be real or intangible things such as financial assets tied to a product, product futures, exchange-traded funds (EFTs), contracts, or real estate investment trusts (REITs). REITs are publicly traded bodies that have a portfolio of properties.
Investment portfolios and bank deposits are usually the most common type of personal financial assets. These can be checking accounts as well as retirement accounts. For a business, it could be stocks and bonds.
The presence of a counterparty is the major difference between financial assets and PP&E (Property, Plant & Equipment) assets, which can be building, machinery, etc. Financial assets can be differentiated into current and non-current assets on the company’s balance sheet.
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Types of Financial Assets
The main types of financial assets are:
- Cash and Cash Equivalents – this includes cash, and cheques available in savings accounts or money market deposit accounts and investment securities. These are short-term assets that can be easily converted to cash or paper money and have less risk of price fluctuation. They can be of higher credit quality also.
- Accounts Receivable – these are short-term assets in business wherein the company/ business signs a contract. The contract guaranteed that the customer will pay for any service or product they may buy, in less than a year. This amount to be collected from the customer is called accounts receivable, and the values of receivables are based on how much is owed, and the probability. This asset is used in balance sheets in many businesses.
- Equity Shares – This is an asset that comes with the co-ownership of a share. Here each member is a fractional owner which gives them the right to vote, the right to the capital appreciation of the stock held, the right to receive the dividends, etc. They can also initiate maximum entrepreneurial liability related to a trading concern. But in the event of liquidation (closing a business or a subsidiary of a business, by selling off its assets), the equity shareholders get almost nothing in a dimeas the amount is used to pay off creditors and the rest of liabilities, etc.
- Bonds/ Debentures – these types of assets are given by the company which gives the holder a salary hike. The holder can receive it on regular interest payments on any fixed date. By the time of maturity, the amount invested is also repaid, and the debenture holder can claim the assets of the issuing company before the rest of the shareholders and equity holders.
- Fixed Deposits –this refers to the amount a business/ individual deposits in a bank or some other organization to earn some interest rate and the principal amount on the maturity date. For example, if an individual deposits an FD of INR 100,000 to the bank at 8% simple interest for a year. The depositor individual will receive IND 100,000 and an additional INR 8,000 interest on the maturing date.
- Preference Shares – Holders of the preference shares give them the right to receive dividends. But this will be a pre-determined amount of shares that is brought by the holder of the company. In the event of liquidation, the preference shareholders will receive the assets of the company first after equity shareholders but second to debentures and bondholders.
- Mutual Funds –Mutual funds are a type of investment usually run by an asset management company where they receive funds from small businesses/ investors. After a suitable amount of money is collected from such investors, these funds are invested in the financial market having a vastly diversified stock portfolio. The investors who initially received units of mutual funds will now receive returns as capital appreciation (this refers to the increased market value of specific assets over a period of time as compared to their purchase price), and any interests/ money received back on the original amount of the investment. But sometimes, this mutual fund unit’s value can decrease, and this results in a loss to the investor/ unit holder.
- Insurance Contracts – As per IFRS 17, insurance contracts are another type of financial asset, wherein the policyholder pays a significant amount of money to the insurance company which ensures the right of getting a compensatory amount in the case of an unfortunate event that may result in the business or company to face with loss. The compensation is only distributed if such a situation is also an insured event. For example, if it is stated that any damages due to a natural disaster such as an earthquake or flood will be covered by the insurance, then any damage incurred to the business in such an event will be covered.
- Derivatives –Derivatives are sort of a contract between two businesses or parties, wherein the values are derived from any underlying assets. These assets can be hedging, index, stock, commodities, speculations, interest rates, currencies, etc. Although, unlike insurance contracts or debentures, the principal amount on investment is not repaid, and the derivatives are received in the form of contracts, options, futures, swaps, etc.
- Employee Benefit Plans –Defined under IAS 19, the employee benefit plan is a post-employment benefit plan where an association uses an actuarial technique or the projected unit credit method, where the total cost to the association for the benefits that employees have earned for their lifetime serviceis estimated. This approach of calculation reduces the fair value of plan assets from the defined benefit obligation, determines the deficit, and determines the total money to be differentiated for profit, loss, and other comprehensive income. Other comprehensive income can refer to income and expenses not realized while preparing the company’s financial statement during any accounting period.
- Certificate of Deposit (CD) – A certificate of deposit is used by a customer/ investor when they deposit a certain amount of money in a bank for a guaranteed interest rate for a certain period of time. These can be held anywhere between three months to up to five years, and the interest is usually paid monthly.
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The most common classification suitable for all the above-mentioned assets are:
These are liquid short-term investments. They are meant to be consumed or sold within a year. These are usually presented on the balance sheet in the order of liquidity, and often include any details about cash or cash equivalents, inventory, accounts receivables, or other short-term assets. The list of current assets includes:
- Cash and Cash Equivalents – Cash equivalents can be money market mutual funds, treasury securities, certificates of deposits, etc. When companies have excess cash, they are invested in low-risk to create additional income. These are called cash equivalents.
- Marketable Securities – These are the securities that are traded on public exchanges very much. These types of securities always have buyers in the market. The two types of marketable securities are – equity and debt securities.
- Inventory/ Stock–The goods or materials that are in stock are called an inventory. These can be raw material inventory, work-in-progress inventory, and finished goods inventory.
- Account Receivables – these are credits given to a customer, which means that the product/ commodity has been delivered to the customer but the payment is not fully done.
- Prepaid Expenses – paying a significant amount in advance to receive coverage of a certain amount for a certain period of time.
- Non-Trade Receivables – For any non-trade activities, these receivables are paid for by employees and vendors.
- Other Current Assets – if a company has any other assets that should be converted to cash within a year but do not necessarily fall under any of the other categories, such assets fall in this category.
These depict the shares of the other company or debentures, held on to for a long period of time. That is, these assets are long-term assets used in the businesses, and the benefits of such assets are reaped after a couple of years. These assets give insight into a company’s investing activities. Non-current assets can be:
- Tangible Assets – Physically existing assets, that can be touched, which can be land, machines, vehicles, grains, minerals, precious stones, etc., are called tangible assets. These are usually valued at costless depreciation.
- Natural Resources – these are assets derived from Earth, having an economic value. These assets, though, are used up quickly with time. These can be oil fields, mines, fossil fuels, petrol, etc.
- Intangible Assets – assets that do not have a physical body but are important in the economic value are called intangible assets. An asset will be considered intangible if certain conditions are met:
- It is identifiable
- The business should have some ways to get economic benefits from this asset.
Patents, copyrights, trademarks, etc. are some examples of this.
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Advantages and Disadvantages of Liquid Assets
Advantages of Liquid Assets:
- Liquid financial assets can be used to pay bills or any financial or medical emergencies, i.e., they can be converted to cash easily.
- It gives a certain amount of security to businesses/ companies that have more capital tied in a liquid asset, and some assets have a certain value appreciation.
- It is an important economic function of financing tangible assets. It is possible to transfer these funds to places where it is needed.
- These assets represent legal claims to future expected revenue.They also help to distribute risk according to preference and risk management of businesses involved in an intangible asset’s investment.
Disadvantages of Liquid Assets:
- Illiquid financial assets will be hard to convert to cash.
- The value of a liquid asset is only as strong as the underlying association.
- Certificate of Deposit, money market accounts, and similar assets would prevent withdrawal for months or years as per the contract.
- Some assets have a date of maturity assigned in the contract, and any attempts to cash out these before their maturation will be subjected to penalties or lower returns.
Asset Management – A Quick Overview
In finance, asset management is simply defined as managing the money of the clients, on their behalf. People who help in this are known as asset managers. Asset managers work for the client’s investment goals by using their money properly, whether it be buying, selling, or holding financial assets. Some of the common assets used for this are bonds, stocks, shares, commodities, etc. Asset management ensures clients with complete discretion or trading authority over their funds to the asset managers, and legally, in turn, these managers are supposed to act in their client’s best interest. Hence, asset management firms are also called fiduciaries.
Thus asset management models are a big deal and are considered to be very important among the asset-heavy business. There are numerous different systems to ensure a value-added way for an organization that controls quite a lot of expensive machines and types of equipment. This helps with its maintenance and long-term viability. Although there are numerous ways of doing a maintenance program, the most fundamental levels of maintenance can be broken down into several steps, each with its own increased levels of interaction and cost. These steps are:
- Regressive – replace the parts
- Reactive – fix the parts
- Planned – fix it before it breaks
- Predictive – improve it
- EAM System – optimization
For cheap and easily available items, it is easier to replace (regressive), but as the equipment value and complexity increase, many different strategies are needed, up to the Enterprise Asset Management (EAM) model. The use of models always depends on the criteria, even for the EAM models which are described as a notional maintenance management entity.
Asset management modeling is a whole system put in place for managing the lifecycle of assets. These management models are made efficient by using different criteria to improve performance, resources, efficiency, etc., as per the client’s demand. Among various models, the three most common asset management models are:
- Institute of Asset Management (IAM) Model – this model was made with regard to ISO 55000 standards. The concept of this asset management model is dependent on six different asset groups. This collection of asset groups will roughly cover around 39 enterprise areas. And these six groups are:
- Asset management decision making
- Strategy and Planning
- Asset information
- Life cycle delivery
- Organization and people
- Risk and Review
- Bottom-Up/ Top-Down Model – the concept of the bottom-up model is that it assumes there to be a fixed number of criteria in place before starting with it, and this can include the existence of facilities, staff training, etc. Once all these are set, the model goes through 5 stages for completion, and these stages are:
- Stage 1 – Gaining control of day-to-day maintenance work
- Stage 2 – Gaining control of equipment condition
- Stage 3 – Creating an environment that allows the maximum contribution to process reliability
- Stage 4 – Eliminating potential failure models
- Stage 5 – Ensuring that all functions manage equipment health
The bottom-up model builds a solid foundation with each stage that works to make a stable strategy that puts the notion of Enterprise Asset Management (EAM) as a priority. This also considers how things can be more beneficial for the customer. This model starts off as a support maintenance program and then it is accepted throughout the company and is gradually leveled up.
The Top-Down model in this regard is the exact opposite. The model starts off with blessings of an EAM strategy by the head/ senior management, who will give the required resources to the maintenance manager to carry out the required maintenance program.
- Integrated Dependencies EAM System Model –this is a business-integrated system that is based on the PAS 55 standard. This model is best used for sustainable strategic planning for the whole company. The strategy is agreed upon by the suitable members but owned by the entire company,and in a way, it is like the top-down model in this regard.
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Frequently Asked Questions (FAQs)
Are financial assets important for the growth of the economy?
Financial assets are important as they help with the cash flow. Such assets transfer funds to the needy from the people who have them in excess.
What is an asset account?
An account that is used to store the debit and credit amounts of transactions from a company. These include accounts receivable, cash, inventory, prepaid expenses, investments, goodwill, vehicles, etc.
What is a balance sheet?
Balance sheets are financial statements/ reports of a company’s assets, liabilities, and shareholder equity over a specific period of time.
Financial assets are vital parts of any company or any business. Companies use such assets to be used whenever, especially in financial emergencies, like a backup plan. Different types of assets give different results, and they have typically different holders as well. Some are good for the short term, and some are good in the long run, but those need a long time before fruits can be reaped from them. And because each type of asset has a certain level of risk factor associated with it, hence, you either need a professional to help you with this, or you can have multiple assets for different purposes. Either way, it’s a great way to increase the cash flow of the company, and it can help in the running of the company even in dire situations. Try out some of the simpler ones and see the difference in your bank account.