Part I · Chapter 1 · Ledger · lesson 3
Assets, liabilities, and things that only look like assets
11 min
Part I · Chapter 1 · Ledger · lesson 3
11 min
A car cost 18,000 three years ago. It would fetch 9,000 today. There is 11,000 still owed on it. It is parked outside and its owner describes it, without blinking, as their second biggest asset.
One of those numbers belongs on the owned side. One belongs on the owed side. And the difference between them is negative 2,000, which is the actual contribution this car makes to the level from the last lesson.
A balance sheet has exactly two columns and one subtraction.
Assets are things you own that have value: cash, a car, a flat, a share of a business, money someone owes you.
Liabilities are amounts you owe: loans, card balances, the rent due at the end of the month.
Net worth is the first column minus the second. That is the entire structure. Everything difficult about it is in deciding which column a thing goes in — and in remembering that owning something and owing money on it are two separate lines, not one.
The car above is not one entry. It is two. There is a 9,000 asset, because that is what the thing would fetch, and there is an 11,000 liability, because that is what is owed regardless of what the thing fetches.
People collapse these into one because in daily life the car feels like one object. The balance sheet does not care what it feels like. If the car were sold tomorrow, 9,000 would arrive and 11,000 would still be owed, and the gap would have to come from somewhere else.
Not the same thing
Something you own, or are owed, that has value to someone else.
An amount you are obliged to hand over, now or later.
Which is which? Put each one on a side.
The 9,000 the car would fetch this afternoon
The 11,000 still owed on that car
The rent falling due at the end of this month
A deposit a landlord is holding on your behalf
A set of tools worth 3,000 that you use to earn a living
Here is a deliberately messy list. It is the shape of the milestone at the end of this track, and it is worth doing slowly.
Check
The awkward category is the one the title of this lesson points at: objects that sit correctly on the asset side and behave, month to month, like the other column.
A car has resale value, so it is an asset. It also demands fuel, insurance, maintenance and a payment, and it loses value while doing so. A holiday property is an asset. It also has twelve months of costs against a few weeks of use. A qualification nobody buys is an expense that was described as an investment at the time.
None of these are accounting errors. The accounting is fine. The error is treating "it is on the asset side" as though it answered the question "is this making me better off", which is a question about flows and has to be asked separately.
Something people say
“Your home is your biggest asset.”
There is a cleaner question than "is this an asset", and it is: what does this do to the flow?
Put every line you own into one of three buckets. It pays me something each year. It costs me something each year. It does neither, and sits there.
The balance sheet tells you where you are. That three-way split tells you which direction you are moving, and the two together are most of what a set of accounts is for. Neither one on its own is enough, which is why the last lesson and this one are two halves of the same idea.