Understanding Assets and Liabilities

Assets and Liabilities

  • Unfortunately many business owners think that by only increasing sales, profit can be increased. However there are other ways to increase profit apart from increasing sales.
  • Profit can also be increased by sourcing cheaper funds and strategically using it to acquire performing assets.

 Every business should understand two things:

  1. Liabilities (borrowed money) are not free. Money borrowed today has to be repaid in the future. There is no liability which does not have a cost.
  2. Every asset will have a corresponding liability. Businesses should realize it does not possess any asset.
  • Let us suppose a fully operational café has 100 assets. It will include both Performing Assets (PAs) and Non-performing Assets (NPAs).
    • PAs are assets that directly help a business in bringing profit Eg: Coffee machine, toaster, oven and so on.
    • NPAs are assets that indirectly help in bringing profit to the business Eg: Tables, chairs, and so on. Non-performing does not mean it is not essential. It is essential, but it will not directly help in bringing in profit to that business.
  • Assume the cost of borrowing to acquire those 100 assets is 10%. So to make profit this café has to earn more than 10%. This means Performing Assets (PAs) should generate a return of more than 10%.
  • Let us see what happens if ratio of PAs: NPAs varies.

If 100 assets are performing assets then to make profit the performing assets should earn more than 10% to make profit. If performing assets is 75% and 25% are non performing assets, then the performing assets has to generate more than 13.33% to make profit. If the PAs (Performing Assets) and NPAs (Non-Performing Assets) is 50-50 then PAs (Performing Assets) will have to generate a return of more than 20% to make profit. If PAs (Performing Assets) are just 25% and 75% are NPAs (Non-Performing Assets) then the PAs (Non-Performing Assets) will have to generate a return of more than 40% to make profit.