For the purposes of accounting, assets held by a company are divided into two categories, current and long-term. Assets a company plans to use for 12 months or more are considered long-term assets. Accounting practices also refer to them as fixed, or capital assets. Long-term assets are considered illiquid because they usually cannot be converted into cash as readily as current assets.
Current assets are those a company expects to consume or liquidate (convert into cash) within 12 months. These can include office supplies, accounts receivable, prepaid expenses, cash on hand, marketable securities and product inventory available to sell.
In this article, we will look at what constitutes a long-term asset and why they are important to companies.
Assets planning to be held over an extended period (one year or more) are considered long-term assets. These can include factories, equipment used in the production of a company’s products, patents, software and capital investments.
Common characteristics of long-term assets include those a company has operated and/or maintained for more than a single fiscal year. Long-term assets are typically employed in the operation and maintenance of a business and are not for sale to the company’s clientele or customer base. In other words, they are items acquired for internal use, as opposed to resale.
Generally, a long-term asset is an investment a company makes that is expected to be of benefit over a span of years.
Common examples of long-term assets include fixed assets such as land, buildings, production machines, and vehicles. These items are also known as property, plants and equipment or PP&E. Long-term investments in other companies such as stocks and bonds fall under the long-term heading as well. All of the above are also considered tangible assets. Intangible assets such as patents, trademarks and goodwill can also fall under the heading of long-term assets.
Changes in long-term assets on a company’s balance sheet can provide clues to the overall health of the company. For example, heavy investment in new long-term assets can indicate that the company is planning for growth. Conversely, selling off long-term assets could be an indication that financial problems are afoot, in that the company needs cash to meet operational costs because revenues are down.
Upon acquiring a long-term asset, a company will record the item’s purchase price. This is also known as its book value. Subsequently, the original cost of the item, less accrued depreciation, becomes the asset’s carrying value. Long–term assets can be depreciated on either a linear or an accelerated schedule, and depreciation can potentially be used to reduce tax liability.
To calculate the true value of a long-term asset, one subtracts accumulated depreciation as well the amount of debt incurred to acquire the asset. When applied to all fixed assets of the company, its net fixed asset value can be determined.
The formula for this is as follows:
Net fixed assets = total fixed assets – (accumulated depreciation + liability)
For investment purposes, analysts tend to look at the value of a company’s assets before depreciation to get a clearer picture of its financial situation. In some cases, depreciation can mask the true value of a long-term asset as it applies to a company’s profitability.
As previously mentioned, the status of a company’s long-term assets can be a clue as to its relative health. New investment in long-term assets signals planned growth. Conversely, selling off long-term assets indicates that a company might be in decline. Used as a tool for analysis, retail investors can glean some insights by paying attention to the long-term assets on a company’s balance sheet.
It is also important to look at a few other aspects of the company.
These include its liquidity before investment, income statement, return on assets, and operating cash flow. A company must have enough cash on hand to meet its expenses. The income statement should evidence earnings growth as well as net income growth.
A strong return on assets (30 percent or better) indicates profitability. Examining the nature of a company’s cash flow can be a clue as to how well it is being run. Ideally the cash flow will be from earnings as opposed to borrowing, and as we mentioned above, selling off long-term assets.
Another key concern for investors should be portfolio diversification, which can serve as a strong hedge against market volatility. Traditional asset allocation envisions a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split incorporating 20% alternative assets may make a portfolio less sensitive to public market short-term swings.
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