What are Fixed Assets?
The term fixed asset refers to a long-term tangible piece of property or equipment that a firm owns and uses in its operations to generate income. The general assumption about fixed assets is that they are expected to last, be consumed, or be converted into cash after at least one year.
As such, companies are able to depreciate the value of these assets to account for natural wear and tear. Fixed assets most commonly appear on the balance sheet as property, plant, and equipment (PP&E).
Fixed assets are items that a company plans to use over the long term to help generate income.
Fixed assets are most commonly referred to as property, plant, and equipment.
Current assets are any assets that are expected to be converted to cash or used within a year.
Noncurrent assets, in addition to fixed assets, include intangibles and long-term investments.
Fixed assets are subject to depreciation to account for the loss in value as the assets are used, whereas intangibles are amortized.
introduction of Fixed Assets
A company’s balance sheet statement includes its assets, liabilities, and shareholder equity. Assets are divided into current assets and noncurrent assets, the difference of which lies in their useful lives. Current assets are typically liquid, which means they can be converted into cash in less than a year. Noncurrent assets refer to assets and property owned by a business that are not easily converted to cash and include long-term investments, deferred charges, intangible assets, and fixed assets.
The term alludes to the fact that these assets won’t be used up or sold within the accounting period. A fixed asset typically has a physical form and is reported on the balance sheet as PP&E. Companies purchase fixed assets for any number of reasons including:
- The production or supply of goods or services
- Rental to third parties
- Use in an organization
Fixed assets lose value as they age. Because they provide long-term income, these assets are expensed differently than other items. Tangible assets are subject to periodic depreciation while intangible assets are subject to amortization.
A certain amount of an asset’s cost is expensed annually. The asset’s value decreases along with its depreciation amount on the company’s balance sheet. The corporation can then match the asset’s cost with its long-term value.
How a business depreciates an asset can cause its book value (the asset value that appears on the balance sheet) to differ from the current market value (CMV) at which the asset could sell. Land is one fixed asset that cannot be depreciated.
Types of Fixed Assets
There are many types of fixed assets, depending on the type of business. Usually they are tangible assets that are not traded for cash or consumed as a core part of the business. Some examples can include:
- Land (however, the land is not depreciable)
- Leasehold improvements
- Office furniture or other property
- IT hardware, servers, and security systems
Key Characteristics of a Fixed Asset
The key characteristics of a fixed asset are listed below:
1. They have a useful life of more than one year
Fixed assets are non-current assets that have a useful life of more than one year and appear on a company’s balance sheet as property, plant, and equipment (PP&E).
2. They can be depreciated
With the exception of land, fixed assets are depreciated to reflect the wear and tear of using the fixed asset.
3. They are used in business operations and provide a long-term financial benefit
Fixed assets are used by the company to produce goods and services and generate revenue. They are not sold to customers or held for investment purposes.
4. They are illiquid
Fixed assets are non-current assets on a company’s balance sheet and cannot be easily converted into cash.
Fixed Assets in Balance Sheet
A balance sheet consists of assets, liabilities, and capital by shareholders. Further, there are different types of assets: current and noncurrent assets. Current assets are liquid assets that can be converted into cash within a period of one year.
At the same time, noncurrent assets include fixed assets, investments by the company, etc., which are not easily converted into cash. In the balance sheet, the fixed asset value is reported after deducting accumulated depreciation. It is rare, but there are chances of value being affected by an impairment or revaluation.
Importance of Fixed Assets
Fixed assets are very important from the beginning. Without considering the value of fixed assets, the possibility of fixed asset turnover, and the life of an asset, it is not possible to accurately understand the viability of the business.
Fixed Asset Turnover
Once we have already invested in the fixed assets, the prime concern of the businessman is to keep a check on fixed asset turnover. There are plants that run 24 X 7 for producing any product. Lack of orders/sales can affect underutilized fixed assets or reduce fixed asset turnover. The business can fall prey to losses, especially due to the cost of using the assets, i.e., Depreciation.
Return on Asset
Financial health is also determined in relation to the return on assets (ROA).
The concept of break-even and margin of safety is largely influenced by dependence on fixed assets.
One of the Porter five forces talks about barriers to entry. The fixed asset is one of the prime Contenders as a barrier simply because the higher the investment in these assets, the larger the amount of total investment becomes.
Decision making/Investment decision
Importantly for any investment decision, it is very essential to forecast the requirement of fixed assets in the business. Any wrong estimation of fixed assets will be very harmful in decision-making.
Benefits of Fixed Assets
Information about a corporation’s assets helps create accurate financial reporting, business valuations, and thorough financial analysis. Investors and creditors use these reports to determine a company’s financial health and decide whether to buy shares in or lend money to the business.
Because a company may use a range of accepted methods for recording, depreciating, and disposing of its assets, analysts need to study the notes on the corporation’s financial statements to find out how the numbers are determined.
Fixed assets are particularly important to capital-intensive industries, such as manufacturing, which require large investments in PP&E. When a business is reporting persistently negative net cash flows for the purchase of fixed assets, this could be a strong indicator that the firm is in growth or investment mode.
Examples of Fixed Assets
Fixed assets can include buildings, computer equipment, software, furniture, land, machinery, and vehicles. For example, if a company sells produce, the delivery trucks it owns and uses are fixed assets. If a business creates a company parking lot, the parking lot is a fixed asset.