Financial Asset is a liquidity asset that derives its value from an ownership or proper contractual claim. Stocks, cash, bonds, mutual funds, and bank deposits are just a few examples of financial assets. In contrast to land, property or commodities, and other tangible physical assets, they do not necessarily possess intrinsic value or even physical forms. Their value is based on the factors of demand and supply within the market where they trade and the level of risk they pose.
Understanding a Financial Asset
The majority of assets are classified as either financial, natural as well as tangible. Real assets derive value from properties or substances like precious metals, land, real estate, and commodities such as wheat, soybeans, oil, and iron.
Intangible assets are the most valuable property that isn’t physical in the physical sense. They can be defined as trademarks, patents, and intellectual property.
Financial assets lie between the two other purchases. Financial help may seem intangible–non-physical–with only the stated value on a piece of paper, such as a dollar bill or a listing on a computer screen. What the listing or report symbolizes, however, is a claim to the ownership of an entity like a public corporation and contractual rights for pay-outs, like an interest-earning income from the bond. The value of financial assets comes from a contractual right to purchase.
The asset underpinning it could be tangible or intangible. Commodities, for instance, are tangible fundamental assets linked to financial assets such as commodity futures, contracts, or exchange-traded funds (ETFs). In the same way, real estate is the actual asset associated with the shares of REITs (REITs). REITs are financial instruments and publicly traded companies with a portfolio of properties.
The Internal Revenue Service (IRS) obliges businesses to declare real and financial assets as tangible assets to be tax-efficient. The categorization of tangible assets must be different from the intangible assets.
- The term “financial asset” refers to an asset with a liquid value that represents derived value from a claim to ownership by an entity or the contractual entitlement to payments made in the future by an entity.
- The worth of a financial asset may be determined by an underlying tangible or real asset; however, market supply and demand also affect the value of the investment.
- Bonds, stocks, cash C.D.s, and bank deposits are all financial assets.
Common Types of Financial Assets
Following the widely referenced definitions from the International Financial Reporting Standards (IFRS), financial assets comprise:
- The equity instruments of an entity, for instance, share certificates
- A right of a contract to acquire an asset of financial value from an entity, also referred to as a receivable
- The right of exchange in a contract to exchange financial assets and obligations with another entity in favorable conditions.
- A contract that settles the entity’s equity instruments 3
Alongside receivables and stocks, the above definition also includes bonds, financial derivatives, other accounts, money market holdings, and equity stakes. Many such financial instruments only have a fixed value once they become cashable, particularly for stocks whose value and prices vary.
In addition to cash, the most common kinds of financial assets investors come across are:
- Stocks represent financial instruments that have no expiration or ending date. A person who purchases stocks becomes an owner of a company and shares in its losses and profits. Stocks can be kept for a long time or sold to investors.
- Bonds are a method of helping governments or businesses finance projects that are short-term in nature. Bondholders are lenders, and the bonds specify the amount of money owed, the interest rate to be paid, as well as the bond’s date of maturity.
- A CD is a certificate that (CD) lets the investor place the amount of money in an institution for a predetermined time frame with a guaranteed interest rate. The CD is a monthly payment of interest and is usually stored for three months to five years, depending on the term of the contract.
Types of Financial Assets Explained in Detail
This article will explain the different kinds of financial assets in depth.
1. Cash and Cash Equivalents
They are financial instruments that comprise cheques, cash, and the money that is available in bank accounts, as well as short-term investments that are easily converted into money with better credit quality. Cash equivalents are liquid assets as they generate income over their short-term period. U.S. Treasury bills, high-grade commercial paper, marketable securities, money market funds, as well as commercial bonds that are short-term in nature are liquid assets.
2. Accounts Receivable / Notes Receivables
Companies use the accrual principle and typically sell to their customers through credit. The amount they receive from customers is known as the accounts receivable, net of the adjustment to lousy credit. Also, it generates interest if the payment isn’t made within the credit day.
3. Fixed Deposits
Fixed deposit facilities are an option for the depositor to interest and receive the principal amount at maturity. Example: Depositor makes an FD of $100,000, with the bank paying simple interest of 8% for one year. The depositor receives $80,000 and $8000 in interest on the maturity date.
4. Equity Shares
Equity shareholders are fractions owners who assume the highest risk of the investment in a business venture. Shares of equity are assets in financial terms that grant the owners the right to vote, to receive dividends, and the right to capital appreciation for the shares held and so on. In the case of liquidation, equity holders are the ones who have the final claim on assets and could/may not be able to receive any benefits.
5. Debentures/ Bonds
The term “bonds” is a financial asset issued by a business that allows holders to receive regular interest payments over fixed dates and the principal amount due upon maturity. In contrast to dividends on equity shares, payments made on debts are required regardless of whether the company has losses. In liquidation, these instrument holders have the advantage over equity and preference shareholders.
6. Preference Shares
The preference shareholders are the owners of preference shares. They allow the owners to receive dividends. However, they don’t possess any voting rights. Like debentures, these shareholders get a fixed dividend rate regardless of whether the company earns profits or suffers losses. Before liquidation, preferential investors have their claims on assets before equity investors, but they can later claim assets than bondholders and debenture holders.
7. Mutual Funds
Mutual funds receive money from investors of all sizes and invest these funds into financial markets, including the equity, commodity, and debt markets. The owner of a mutual fund gets units for their investment. The team is sold and bought in markets based on market prices. The investment’s return is the amount of the capital appreciation and any revenue generated from the initial amount the fund invested. In the same way, the unit’s value may decrease and result in a loss for the owner.
8. Incentives in associates, subsidiaries, and joint ventures
A business with over 50% of its stock is controlled by a different industry ( parent company) and is considered a subsidiary. A parent company can consolidate the financials of its operations, including the subsidiary operations, and then include them on its consolidated financial statement. A subsidiary will provide the parent company with dividends and a part of the earnings.
Joint ventures are arrangements between the parties who are shared control over rights to the Net asset of the partnership. An associate is a person or entity in which an investor controls (20 percent) or greater than 20% of the voting power (significant control). In contrast to an affiliate that is a subsidiary, the Investor Company does not consolidate the association’s financials but instead records the value as an investment in its balance account. The profit earned from the partnership is divided and recorded in the Investor books.
9. Insurance contract
According to IFRS 17, contracts in which one person (issuer) takes on substantial risk of insurance and agrees to compensate another party (policyholder) when an uncertain future event may be an insured risk is detrimental to the policyholder are called insurance contracts. Thus, the worth of the contract comes from the dangers the policy protects.
Insurance policies for life pay out the holders at the time of maturity. They are considered financial assets at the date of maturity. These policies cover the maturity amount for the insurance policy.
10. Rights and Obligations in leases
The term “lease” refers to a contract under which one of the parties allows another person to use the property for a specific period in exchange for a periodic payment. These receivables are considered financial assets because they are an asset for the company to be used by a different entity.
11. Share-Based Payments
Share-based payment arrangements are made between an entity and a third party that allows another party cash following the equity instruments owned by the entity, such as shares and options to purchase shares. For instance, an entity buys specific assets in exchange for equity instruments held by the entity.
The term “derivatives” refers to contracts in which value comes from the asset utilized for hedges, speculation, or arbitrage opportunities. But unlike debt instruments, there is no principal or investment income derived from a derivative contract. Common derivatives comprise futures agreements, contracts, or swaps.
13. Employee Benefit Plans
It is a defined benefit program is an employee benefit plan that is established under IAS 19 whereby an entity employs an actuarial method, i.e., the method of projected unit credit, to calculate the total cost for the entity of the benefits that employees earned for their services during the prior and current period. Furthermore, the method reduces the benefits calculated about their value at present, then subtracts the fair market value of assets in the plan from the defined benefit obligation, determines the surplus or deficit, and, in the end, determines the amount that will be recognized as profits and losses and other general income.
Pros and Cons of Highly Liquid Financial Assets
The purest form of financial assets is cash and cash equivalents–checking accounts, savings accounts, and money market accounts. Liquid funds can be easily converted into money to pay bills and cover urgent financial needs or emergencies.
Different types of financial assets may need more liquidity. “liquidity” is the capacity to transform financial support’s value into cash rapidly. In the case of stocks, investors can purchase or sell their holdings in a ready market. Liquid markets have plenty of buyers and sellers, and there isn’t a long delay when making the trade.
In the case of equity, such as bonds and stocks, investors must sell the asset and wait until the settlement date to receive their funds, usually within two days. Other financial assets come with different timeframes for settlement.
The ability to keep the funds in liquid financial assets could lead to more significant conservation in the capital. Bank savings, checking, and CD accounts are protected against loss of as much as $250,000 through the Federal Deposit Insurance Corporation (FDIC) for credit union accounts. If for whatever reason, the bank fails, your account is covered by an insurance policy that covers up to $250,000. But, because FDIC protects each financial institution in its way and a person who has broken-down C.D.s that total more than $250,000 within one bank is subject to loss if the bank is bankrupt. 4
Liquid assets such as checking and savings accounts cannot provide a return on investments (ROI) capability. ROI is the return you earn from an asset multiplied by the purchase price. In savings and checking accounts, the return on investment is low. They might offer a modest interest; however, unlike equity, they do not offer much appreciation. In addition, C.D.s and market accounts limit withdrawals to months or even years. When interest rates are low, the callable C.D.s are frequently called, and investors wind shifting their money into investments with lower potential income.
Illiquid Assets Pros and Cons
The opposite of liquid assets is a un liquid asset. Antiques and exemplary real estate are two examples of financial support. These assets are valuable; however, they are not able to convert into cash in a short time.
Another instance of a un liquid financial asset does not see an abundance of trades on the market. These are often investments like penny stocks or high-yield investment options, such as speculative ones that may have yet to be an immediate buyer when you’re ready to sell.
The idea of putting too much money into investments that aren’t liquid can have disadvantages, even in normal circumstances. In the event, this could lead to the person using a high-interest credit card to pay expenses, resulting in a rise in debt and negatively impacting retirement and other investing goals.
Real-World Examples of Financial Assets
Both businesses and individuals also hold financial assets. For instance, in the case of an asset management or investment firm, the financial assets are the funds in the portfolios that the firm manages for its clients, also known as assets under management (AUM). For example, BlackRock Inc. is the most significant investment manager of its kind in the U.S. and the world, as indicated by its $6.84 trillion AUM (as of June 30, 2019, 2019).
In the case of banks, their financial assets are the number of outstanding loans it has granted to their customers. Capital One, the 10th-largest lender within the U.S., reported $373,191 million of total assets in its first-quarter financial report of 2019. Of the total, $240,273 million came from commercial, real estate-secured industrial, and real estate-secured loans.
A legal claim on something of value. Modern economies comprise four financial assets: bank deposits, bonds, stocks, and loans.
Financial assets are classified as non-current or current assets on a company’s balance sheet.
Bonds, deposits, stock notes, currencies, and other instruments that have value and are subject to liabilities, claims, or equity investments. Financial assets are banks’ loans, direct investments, official private holdings of equity and debt securities, and different instruments.
In terms of accounting, your car is an asset that is depreciating. That means that your car may have value today, and you may be able to sell it. While you own the car, the value typically decreases over time.
How To Create Your Asset List
- Choose the method you’d like to use to organize your list of assets.
- Choose the items you want to be added to your inventory of assets.
- Take important documents.
- Keep your list of assets in secure storage.
- Update your asset list. Your estate plan goes further than just a legal document.