Know the difference between an asset and a liability. Even for some of us accountants, the clarity between assets and a liability is not so clear. For example, is a car an asset?
Take the following test:
- Does your car have potential to increase future cash flows?
- Does the benefits your car offers exceed the costs of ownership in the long term?
- Does your car have a resale future value higher than the purchase and maintenance costs combined? Does your asset have readily available buyer anytime you would want to dispose of it?
You get the idea.
An asset should bring you income that exceed the costs of operations over the ownership years.
A business car, for example, has potential to bring future cash flows. A tractor, used for farming, has potential to bring future cash flows. You must carefully keep proper records to examine the costs of ownership i.e. purchase, maintenance, future, parking fees and insurance against the benefits derived.
Granted, a personal car offers benefits of convenience. You don’t have to get wet in the rains. You can plan your movements. It gives you pride. And if you are a consultant, it offers that sense of seriousness – no executive would be comfortable spending money to a consultant who comes to pick a check all drenched in wet clothes and dirty shoes!
Most Indians have clarity of an asset and a liability. They see some personal indulgencies like a car (an expensive and high maintenance one) as excessive and expensive to the success of the business. So in the early start up days, they will happily ride to work on a motorcycle or bicycle. When they opt to own cars, they will be careful to buy cars with high resale value. Many Indians focus on owning assets – land and buildings and income generating projects and businesses.
If it has no potential to bring more income to you in future, it is a liability. For example, education is considered the best investment or asset, because it gives you the power to think and make a successful livelihood.
Before you spend that money on any asset: ask it is really an asset or a liability.