by Marija Josifovska
by Marija Josifovska
Purchasing land is usually a long-term investment that provides value for a longer period of time. Practice shows that land isn’t typically turned into cash within one year of the purchase. However, while it is considered a fixed asset, there are some examples of when you can classify it as a current asset. Find out when this happens and learn all about the different types of assets and how they can impact your business.
The Importance of Asset Classification
Classifying assets as current or long-term is important so that you understand which investments can be quickly liquidated when cash is needed. Additionally, such classification helps you evaluate your business net capital and assess the company’s risk and solvency.
The assets are generally categorized into two categories: current and long-term. Categorizing them on a balance sheet can get confusing. Let us guide you through the process of dividing your assets, including land.
Current or liquid assets are those that can be easily liquidated within a year. They can also be turned into cash you can use to finance daily business activities. For example, you could use current assets to pay for operational expenditures or any short-term financial obligations.
The value of current assets can help you assess the business’ liquidity. This is important in determining whether the company has enough finances to cover obligations like payroll and bills. What is more, current assets are analyzed by investors and creditors to better learn the company’s value and determine if there are any operational risks.
Types of Current Assets
- Cash – the liquidated funds available for spending.
- Cash equivalents – the outstanding checks, foreign currency, or treasury bills that can be quickly liquidated if needed.
- Inventory – the finished products or raw materials your company stores.
- Accounts receivable – the money that a third party owes to your company for a product or service.
- Short-term investments – securities like public stocks and bonds that can be sold and liquidated within a year.
- Prepaid expenditures – the payments made in advance to a third party for a future service or product like rent and utilities.
Financial Ratios To Calculate The Company’s Liquidity Position
Categorizing the company’s current assets can be tricky, especially when considering a period of more than a year. In these cases, you can use ratios to measure your company’s liquidity position.
To gain an insight into your business’s ability to cover short-term and long-term obligations, use the current ratio which you can measure by considering the total current assets concerning current liabilities. The quick ratio, on the other hand, shows the company’s ability to fund short-term obligations using liquid assets like cash, cash equivalents, and accounts receivable.
Finally, you should use the cash ratio to measure the capacity to cover all short-term commitments immediately. It’s calculated by dividing the cash and cash equivalents by current liabilities in order to calculate it.
Long-term or fixed assets are the tangible assets used in daily business operations and aren’t liquidated within a year of their acquisition. The fixed assets are very important as they are obtained to help the company run and generate income. Additionally, they add to a business’s financial reporting, financial analysis, and business valuations.
Types of Long-Term Assets
- Tangible assets – physical assets that can be seen and touched like machinery, company vehicles, building, and land.
- Intangible assets – non-physical assets that cannot be touched or seen, including copyrights, goodwill, and patents.
- Wasting assets – assets whose volume reduces on usages like mineral, coal, and oil deposits.
Is Land an Asset or Equity?
Land is most often classified as a long-term asset on a business balance sheet. In most cases, it is considered the least liquid asset a business owns as well as the asset with the longest lifespan.
Since it cannot be depreciated, it essentially has an eternally useful life. In simpler terms – you cannot account for its cost by gradually reducing its value over its lifespan. If the market value of the land purchased for business use increases over time, its value on the balance sheet would remain the same.
Land equity is the difference between the land’s value and how much you owe on it. So if you sell your land, the land equity would be the amount you have left. You can then use land equity as collateral for loans.
Can Land Be a Current Asset?
Now that you fully understand the nature of current and long-term assets, you know that the asset classification largely depends on its nature and use. Even though land is considered to be a long-term asset, there are a few exceptions.
Before you categorize land on the balance sheet, consider whether it was purchased as a short-term investment that will be sold quickly or as a long-term investment that would be used for day-to-day business operations.
For example, real estate companies might buy land and flip it for profit within a year. These companies would have to list the land as a current asset. On the other hand, an IT company that buys land to build office spaces and use it as a place for business operations would have to consider the land as a fixed asset.
In short, if the land’s usage period exceeds one year, you should categorize it as fixed assets. On the other hand, if you’re planning to liquidate the land within one year, you should classify it as a current asset.
Final Words: Is Land an Asset?
Depending on its use, land can be a current or long-term asset. However, in the majority of cases, it’s a long-term asset because it’s often kept for more than a year. It is one of the few tangible assets you could own whose value appreciates over time. For this reason, businesses that buy land for profit usually hold on to it for a longer time.
If you have purchased land and you wonder how to categorize it on the balance sheet, consider the two most common scenarios. Plan whether you’ll be selling your lot within a year or not and whether you’ll be using it for daily operations. Based on this, you’ll be able to decide if it’s a current or long-term asset.