A long-term asset is an important component of sound financial management in many sectors. Long-term use and maintenance of these assets can also give financial benefits to businesses. Understanding how to use them successfully, on the other hand, is critical to establishing a profitable business. We define long-term assets in this article, analyze their common qualities, present examples on the balance sheet, and discuss the potential benefits of retaining these assets.
What are Long-Term Assets?
Long-term assets are assets used in a company’s manufacturing process that have a useful life of more than one year. These assets are also known as “fixed assets” since they can represent a significant amount of the company’s fixed costs associated with manufacturing. For example, an automotive manufacturer may regard factories as long-term assets because they are at the heart of the company’s production process.
Regardless of the company’s monthly or yearly output, the costs of running the factories do not vary significantly and account for a major amount of the company’s cost of goods sold (COGS). The factories would be considered long-term assets. Depreciation must also be applied to assets throughout the length of their useful life.
Identifying Long-Term Assets on the Balance Sheet
There is no accounting formula that classifies an asset as a long-term asset. In the balance sheet, the assets having a life value are classified as long-term assets. A long-term asset must have a lifespan of more than one year. A long-term asset cannot be classified as a current asset because a corporation can readily turn a current asset into cash within a year.
The balance sheet shows the company’s liabilities, shareholder equity, and assets, which include both long-term and current assets. Assets = shareholder equity + liabilities on the balance sheet The equation is so because a firm can only buy assets with the funds it receives through shareholder stock and loan payments.
Long-term Asset Characteristics
If you’re looking for long-term assets on a balance sheet, you might seek the following characteristics:
- A corporation has used and maintained them for more than one fiscal year.
- They have been utilized by a company to assist in the operation and maintenance of its business.
- A company has no intention of reselling them to its customers or clients.
Recognizing these common traits might assist you in identifying the asset kinds of a corporation. Understanding their common qualities may also assist you in recognizing when a company may be experiencing financial difficulties. For example, if a corporation sells assets it has owned for a long period, it may indicate that it requires greater revenues in the short term to meet operational needs.
How Do Long-Term Assets Get Used?
Long-term assets account for a sizable portion of the company’s total fixed costs, which will be helpful in the future. Data about an organization’s long-term assets is crucial because it aids in the preparation of reliable financial reports, business valuations, and financial analyses. Every fiscal year, the corporation reports long-term assets on their balance sheet. It records the asset’s initial purchase price rather than the asset’s current worth. They are made up of both tangible and intangible assets. They include the following:
- Long-term investments comprise the company’s stock and bond holdings, any property it is planning to sell, and its bond sinking fund. The value of the company’s life insurance policy might also be included in long-term investments.
- Any intangible assets acquired by the company in a deal, such as patents, customer lists, trademarks, copyrights, domain domains, and goodwill.
- Plant and equipment property Buildings, land, machinery, cars, fixtures, and any other equipment used by the corporation to run the business are all classified.
Deferred assets are assets that do not fit into any of the following categories. Deferred assets are assets that are paid for in advance by the company, such as prepaid rent or insurance to purchase the service.
Advantages of Retaining Long-term Assets
Maintaining valuable long-term assets can give businesses with a variety of commercial benefits, including:
#1. Reduced expenses
Reduced expenses may be a benefit that assets gain from long-term asset maintenance since they can deliver functional qualities that can help them save money. Tangible assets, such as property or equipment, can assist raise profitability by allowing businesses to avoid external costs more easily. For example, if a corporation owns its own land, it is unlikely to require the use of commercial space. If it possesses its own equipment, it is unlikely to need to rent equipment or work directly with outside businesses.
Long-term intangible assets, such as software or innovations, can also help businesses cut costs. For example, if a corporation employs its own internal software or technology, it is unlikely to require the acquisition of external options. Both asset types may help firms reduce operational costs over time.
#2. Increased Profits.
If a company’s costs are reduced, it may also see a rise in earnings. Long-term tangible assets, such as property or equipment, can help organizations generate profits by allowing them to more readily streamline their operations and boost productivity. This boost in productivity could be attributed to their improved capacity to handle everyday activities effectively and efficiently in order to accomplish goals.
Intangible assets, such as investments or patents, can help firms develop value through strategic monetary allocation and ownership rights. This increase in wealth could be attributed to a return on investment or profit from patented or copyrighted firm materials. Both asset categories may help organizations boost their overall earnings over time.
#3. Increased Expansion
Increased growth may be the result of lower company costs and more profitability. Comprehensive financial growth may enable businesses to broaden their branding, reach, or products and services. For example, a company that is seeing lower expenses and more profits from its long-term assets may expand by investing in more of these assets or boosting expenditures to assist expand its brand and offers. In exchange, the company’s potential to grow and expand may result in significant profit rises.
The time it takes a corporation to attain its growth goals may be influenced by the number of assets it keeps over a long period of time. A company that only owns a few of these assets, for example, may take longer to reap the benefits of expansion than a company that owns many of these assets. Other factors, such as firm size or industry, may also influence the higher growth benefits that businesses enjoy.
Long-Term Assets Depreciation
Long-term assets, like most other types of assets, must be depreciated over the duration of their useful life. It is because a long-term asset is not expected to deliver a benefit indefinitely. Machines in an automobile manufacturing, for example, will age and may encounter malfunctions or fall victim to obsolescence.
A corporation can depreciate its assets using a variety of accounting techniques, such as the double-declining balance approach, the units of production method, or the straight-line depreciation method. It should be noted that depreciation is not a cash expense for the organization.
Depreciation amounts incurred for the purpose of depreciating fixed assets serve as a tax shelter for the company’s earnings. To determine taxable income and tax expense, depreciation is removed from EBITDA.
Long-Term Asset Terminology
It is necessary to become acquainted with specific terms in order to better comprehend how these assets affect a company’s financial health.
#1. Property, Plant, and Machinery
This refers to a company’s long-term assets that are critical to the manufacturing process. Property refers to any property or proprietary assets used in the company’s production. Buildings and factories that are necessary for production are referred to as plants.
For example, if a firm decides to purchase the property on which its plants are located, this land would be classified as PP&E. Machines and other production aids that a corporation uses in its manufacturing process are referred to as equipment. In general, this category contains the majority of a company’s long-term (or fixed) assets.
#2. Book Value
When a corporation purchases PP&E or other long-term assets, it initially records the value of the assets at the time of acquisition, which becomes its “book value.” The amount is often reported as the purchase price paid by the corporation to acquire the asset.
#3. Carrying Value
The carrying value of a long-term asset (also known as the net book value) is the asset’s value on the company’s books. The carrying value is the asset’s original cost less any accrued depreciation. It can be thought of as the asset’s historical accounting value.
Long-Term vs. Short-Term Assets
Current and non-current assets are the two basic types of assets on a balance sheet. On the balance sheet, current assets include all assets and holdings that are anticipated to be turned into cash within a year. Current assets are used by businesses to fund ongoing operations and pay current expenses such as accounts payable. Cash, inventories, and accounts receivable are examples of current assets.
Non-current assets are long-term assets with a useful life of more than a year and typically last for several years. They are deemed less liquid, which means they cannot be easily converted into cash.
Long-Term Assets’ Limitations
Long-term assets can be costly and need substantial quantities of capital, which might deplete a company’s cash reserves or increase its debt. One restriction of examining a company’s long-term assets is that investors may not realize the benefits for a long period, possibly years. Investors must rely on the management team’s ability to forecast the company’s future and deploy cash wisely.
Earnings are not generated by all. Drug companies spend billions of dollars on R&D to develop new treatments, but only a few make it to the market and are successful.
Investors should examine a company’s long-term assets in the balance sheet holistically, just as they would any other financial indicator. When conducting a financial study of a company, it is best to use numerous financial ratios and indicators.
Changes in Long-Term Assets
Any changes in long-term assets can result in capital investments or asset liquidation. A corporation, for example, that wishes to invest in its economic growth will spend its resources to purchase a variety of assets. Investors should be aware, however, that not all corporations hold their long-term assets for more than a year. Some businesses raise their operational costs or pay off debt by selling long-term assets. Circumstances like this indicate that the company’s finances aren’t in excellent shape.
How Do You Get Rid of Long-Term Assets?
There are several ways for disposing of long-term or plant assets at the end of their useful life:
- Discard: Tossing the asset when it has served its purpose.
- Sale: Which entails exchanging an asset for money.
- Exchange: Which entails exchanging one asset for another.
Conclusion
Before making an investment decision, investors should examine a company’s long-term assets, as not all investments create returns. When examining a company’s financial situation, it is prudent for an investor to employ several financial indicators and ratios.
Long Term Assets FAQs
What are examples of long term assets?
Fixed assets such as property, plants, and equipment, which might include land, machinery, buildings, fixtures, and vehicles, are examples of long-term assets.
What are long term and short term assets?
Long-term assets are those that are utilized in the business for a long length of time, i.e. more than a year, to produce revenue, whereas short-term assets are those that are employed for less than a year and generate revenue/income within a year period.
Is furniture a long term asset?
Furniture and fixtures are larger movable pieces of equipment used to furnish an office. Bookcases, chairs, desks, filing cabinets, and tables are some examples. This is a popular fixed asset categorization that is included as a long-term asset on a company’s balance sheet.
