Tips for Classifying Assets or Liabilities

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Written by

Deolu Akinyemi

useful-tips

To know if you can classify something as asset or not, ask, “does it have positive passive cash flow?” So, if it’s shares, are you being paid dividends? If it’s a house does it give you rent? If it’s a business, do you not need to be involved before you earn the income that is associated with it? If it’s intellectual property, do you earn royalty without your effort, if it’s a network marketing business, has it grown to a point where without your involvement it continues to generate passive income?

What you use to classify anything as an asset is not the value of the property in storage but the value in cash flow. If it has capital gains, it’s a business. What does that mean? It means if I buy land and this land I am buying has a value of 200,000 Naira today and it has the potential of appreciating to two million in the next two years, would I classify that as an asset? No I won’t, I’ll classify it as a business, I can make profit, and I can make a loss. However, if I rent out to a farmer who pays me 15,000 Naira per annum then I have an asset. I have a positive cash flow of 15,000 Naira per annum. Which is equivalent to 1200 Naira per month. This gives me passive income when I have rented it out. But as long as the land is there and is giving no passive income in the short term, what I have is a business. If I will make money when I sell it, what I have is a business. If it has positive and passive cash flow its an asset. If I have a property or house that I put under management and its fetching rental income on a regular bases I have an asset. If I have land and I lease it out and somebody is paying me rental income for leasing it, I have an asset. However if I have land and I’m paying for perimeter fencing, survey, Certificate Of Occupancy and its giving me no value in the immediate but I can sell it for more value, I have a business.

If the property I have has negative cash flow, if rather than give me money on a regular bases, its taking money from me and I don’t have an end in sight of when I would sell it for profit, what I have is a liability.

I’ll give you an example, somebody came to me one day and said to me; my father left me a 22 room apartment in the village before he died. I thought what he left me was a very good thing until I realized that every Christmas I go home, the people who are living in the house who are family members, ask me for money to fix the light bulbs, to fix the plumbing, to clear the grass and to do things around the house, nobody is paying any income for that house, I’m the one servicing it and maintaining it and people are living in it for free. What does he have? An asset or a liability? Well I told him, “unfortunately your father has not left you anything that brings you money, he has left you with a liability that is taking money from you. What you have in your hands is not an asset it’s a liability”.

So I explained to him, that this 22-room apartment only becomes an asset when he takes it over, takes charge and converts it into a hotel. He can then look for some value to add to it and ensure that rental income is coming in, otherwise what he has, so far it doesn’t give him cash flow is a liability.

Please answer these questions very carefully: think about this, your landed property that you have, is it bringing in any positive cash flow, is it a business, an asset or a liability? Your personal house, the one you built with 10 million , the one you built with 15 million , the one you spent 45 million Naira on and is built far away from town where land there is not even registered but you managed to be living in it. How much is it costing you to maintain it? Are you making money from it? Is it a liability? Or is it a business?

Your business is a business until you are able to build it to a point where your business can survive without you, then, you have an asset. Every business is an asset in the making, but till you leave it and it is able to deliver value without you, that is when you can call it an asset.

Traded shares; you buy shares; you buy and read the newspaper every day to see if the price has gained or lost. You are a regular at the investment columns, how much is Okomu oil, has it lost or gained 1 Naira. Finally you are able to find a good price, it gained 10%, and you sell it to make money. What you have is not an asset, what you have is a business. You are a trader! What you are doing is trading. It is in no way different from what spare part sellers or farm product sellers do.

I tell people, not many of the things you think are asset can be classified on your personal financial statement as assets. Categorize them correctly, whatever is giving you passive income is an asset because you want financial freedom. Whatever is not bringing in passive income is not an asset. It is either a business or a liability. Understand this and begin to check through your workbook, in my balance sheet what do I have as assets and which ones are liabilities. What does my income statement look like?

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