Companies or businesses use assets to generate value from their operations. These assets may have several forms or types. Among those, companies may have financial and real assets. It is necessary to look at both of them individually to understand the differences between them.
What are Financial Assets?
A financial asset is usually an intangible asset that gets its value from a contractual claim. Financial assets are liquid assets that companies use in their daily operations. These may consist of cash, stocks, bonds, mutual funds, etc. Financial assets are different from real assets, such as land, property, or other intangible assets. Similarly, financial assets usually involve a counterparty in the deal.
For most companies, deriving the value of financial assets may be an issue. These assets don’t have a single measurement technique that can apply to each item within it. For some small financial assets, the current market price can be a reliable measure. However, for companies with bigger financial assets, it may not be a reliable measure.
Therefore, companies may use several techniques to value their financial assets. These may include the equity method of account or amortized cost method. Some financial assets also require companies to use the fair value method of accounting through either profit or loss or other comprehensive income.
Lastly, most financial assets are short-term. It is because most of these represent liquid assets. Therefore, companies classify them under the portion of the current assets of their Balance Sheet. However, some companies may hold specific financial assets for long-term purposes. In that case, the classification may shift to non-current assets.
What are Real Assets?
As the name implies, real assets are physical assets. They have an intrinsic value due to their substance and properties. These may include assets, such as land, property, equipment, natural resources, real estate, etc. Similarly, companies use these assets as a tool to generate income. These are different from financial assets or intangible assets in their characteristics.
Real assets are more stable compared to financial assets. However, due to their stability, they may be less liquid. Similarly, these assets don’t suffer due to changes in inflation, currency exchange rates, or other macro-economic factors in the same manner. Usually, they have a strong negative correlation with financial markets.
Apart from companies, real assets may also be a viable option for investors. Investors usually prefer to invest in financial assets. However, real assets present an opportunity for them to diversify their portfolio outside of the asset class. Investing in these assets is a strategy that investors utilize in asset allocation to create a diversified investment portfolio.
For companies, real assets represent long-term assets. Therefore, they classify these assets as non-current in the Balance Sheet. However, for short-term real assets, the classification may change to current. There are also some other costs associated with these assets, which companies may charge through the Income Statement. Most of these assets come with the depreciable value and may accumulate depreciation over time.
Financial assets are highly liquid assets, which means they are either cash or readily convertible. These assets usually involve a counterparty and may be short-term. On the other hand, real assets are the opposite. These don’t usually involve a counterparty and represent value-driven physical assets. Similarly, they are often long-term.