What are Financial Assets?
Financial asset can be defined as an investment asset whose value is derived from a contractual claim of what they represent. These are liquid assets as the economic resources or ownership can be converted into something of value such as cash. These are also referred to as financial instruments or securities. They are widely used to finance real estate and ownership of tangible assets.
These are basically legal claims and these legal contracts are subject to future cash at a predefined maturity value and predetermined time frame.
Types of Financial Assets
These all can be classified in different categories according to the features of the cash flow associated with them.
Major types of financial assets are as follows:
#1 – Certificate of Deposit (CD)
This type of financial asset is an agreement between an investor (here, company) and a bank institution in which the customer (Company) keep a set amount of money deposited in the bank for the agreed term in exchange for a guaranteed rate of interest.
#2 – Bonds
This type of financial assets is usually debt instrument sold by companies or government in order to raise fund for short-term projects. A bond is a legal document that states money the investor has lent the borrower and the amount when it needs to be paid back (plus interest) and the bond’s maturity date.
#3 – Stocks
Stocks do not have any maturity date. Investing in stocks of a company means participating in the ownership of the company and sharing its profits and losses. Stocks belong to shareholders until and unless they sell them.
#4 – Cash or Cash Equivalent
This type of financial assets is the cash or equivalent reserved with the organization.
#5 – Bank Deposits
These are the cash reserve of the organization with Banks in saving and checking accounts.
#6 – Loans & Receivables
Loans and Receivables are those assets with fixed or determinable payments. For banks, loans are such asset as they sell them to other parties as their business.
#7 – Derivatives
Derivatives are financial assets whose value are derived from other underlying assets. These are basically contracts.
All the above financial assets are liquid assets as they can be converted into their respective values as per contractual claim of what they represent. They do not necessarily have inherent physical worth like land, property, commodities etc.
Financial Assets Classification
There is no single measurement classification technique that is suitable for all financial assets. Financial Assets can be classified as Current Assets or Non-Current Assets on a company’s balance sheet.
#1 – Current Assets
This contains those investment assets which are short term in nature and are liquid investments.
#2 – Non-Current Assets
Non-Current assets like shares of other company or debt instruments held in portfolio for more than a year.
Advantages of Financial Assets
- Some these assets which are highly liquid can easily be used to pay bills or to cover financial emergencies. Cash and cash equivalents come under this category. On the other hand, one may have to wait for the stock to get money as they have to be sold in exchange first followed by settlement.
- For investors, it gives them more security when they have more capital parked in liquid assets.
- It serves a major economic function of financing tangible assets. This becomes possible with the transfer of funds from those who have a surplus of it to where it is needed for such financing.
- It distributes the risk as per preferences and risk appetite of the parties involved in the investment in tangible assets. Its represent legal claims to future cash expected generally at a defined maturity and defined rate. The counterparties involved in the agreement are the company that will pay the future cash (issuer) and the investors.
Disadvantages and Limitations of Financial Assets
Although, financial assets have many pros on the flipside,
- Financial asset (liquid assets) like deposits in savings accounts and checking accounts with banks are greatly limited when it comes to its return on investment, as there are no restrictions for their withdrawal.
- Furthermore, these assets like CDs and money market accounts may prevent withdrawal for months or years as per the agreement or they are callable.
- This majorly come with a maturity date in the contract, attempting to cash out assets before maturity calls for penalties and lower returns.
Important Points About Financial Assets
- The value of this asset is determined by the demand and supply of such asset in the market.
- These assets are valued as per the cash required to convert them which again is decided based on certain parameters. The value of people’s financial assets can change significantly, especially in the case they have invested majorly in stocks.
- Measurement of financial assets cannot be done using a single measurement method. Suppose we are measuring stocks when investments are small in quantum, the market price can be considered to measure the value of the stock at that time. However, if a company owns a large number of shares of other company, the market price of the share is not relevant because the investor holding majority shares may not sell them.
- Every financial asset has a different risk and returns for its purchaser. For instance, a car company usually have no idea of the sale of its cars, so, the value of stocks of the company may increase or decrease. Bond can default as issuers may fail to pay back the par value of a bond. Even cash and savings accounts have risk associated as inflation may put an impact on purchasing power.
These are a crucial part of any organization. It always needs to have a good record of its financial assets so that is can be put to use whenever needed like in financial emergencies. It is helpful to keep a check on the availability of financial assets.
Each and every financial asset has a different but particular goal for the holder, each has a different amount of risk associated with it and thus returns are also different based on risk for the purchaser of financial asset. Since each type of financial assets has some reward & risk associated with it, it’s always advisable to keep a mix of different asset types to have an optimal portfolio. This helps in the proper functioning of the organization without any dearth of assets.
This has been a guide to what are Financial Assets and its definition. Here we discuss the types of Financial Assets and its classification along with examples, advantages, and disadvantages. You may also learn more about the following articles –