What are Financial Assets?
The financial assets 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 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 flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. associated with them.
#1 – Certificate of Deposit (CD)
This 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 financial asset is usually a debt instrumentDebt InstrumentDebt instruments provide finance for the company's growth, investments, and future planning and agree to repay the same within the stipulated time. Long-term instruments include debentures, bonds, GDRs from foreign investors. Short-term instruments include working capital loans, short-term loans. sold by companies or the government to raise funds for short-term projects. A bond is a legal documentA Bond Is A Legal DocumentA bond is financial instrument that denotes the debt owed by the issuer to the bondholder. Issuer is liable to pay the coupon (an interest) on the same. These are also negotiable and the interest can be paid monthly, quarterly, half-yearly or even annually whichever is agreed mutually. 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 shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares. until and unless they sell them.
#4 – Cash or Cash Equivalent
This type of financial assetType Of Financial AssetFinancial assets are investment assets that derive their value from a contractual claim of what they represent. Cash and cash equivalents, accounts receivable, fixed deposits, equity shares, debentures/bonds, preference shares, mutual funds, interests in subsidiaries, associates, and joint ventures, insurance contracts, rights and obligations under leases, Share-Based Payments, Derivatives, and Employee Benefit Plans are all examples 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 accountsChecking AccountsChecking Account, also known as a transactional account, can be defined as a kind of deposits account held by a financial institution or non-banking financial institution which allows the holder of the account to deposit and withdraw money. This is one of the most liquid forms of money. It differs from a normal bank savings account since it allows multiple deposits and withdrawal in a particular period..
#6 – Loans & Receivables
Loans and Receivables are those assets with fixed or determinable payments. For banks, loans are such assets as they sell them to other parties as their business.
#7 – Derivatives
DerivativesDerivativesDerivatives in finance are financial instruments that derive their value from the value of the underlying asset. The underlying asset can be bonds, stocks, currency, commodities, etc. The four types of derivatives are - Option contracts, Future derivatives contracts, Swaps, Forward derivative contracts. are financial assets whose value is derived from other underlying assets. These are basically contracts.
All the above assets are liquid assetsLiquid AssetsLiquid Assets are the business assets that can be converted into cash within a short period, such as cash, marketable securities, and money market instruments. They are recorded on the asset side of the company's balance sheet. as they can be converted into their respective values as per the contractual claims 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 these assets. It can be classified as Current AssetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc. or Non-Current AssetsNon-Current AssetsNon-current assets are long-term assets bought to use in the business, and their benefits are likely to accrue for many years. These Assets reveal information about the company's investing activities and can be tangible or intangible. Examples include property, plant, equipment, land & building, bonds and stocks, patents, trademark. on a company’s balance sheet.
#1 – Current Assets
It 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 companies or debt instruments held in portfolio for more than a year.
- Some of 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 as a major economic function of financing tangible assets. It becomes possible with the transfer of funds from those who have a surplus of it to where it is needed for such financing.
- Financial assets distribute the risk as per preferences and risk appetite of the parties involved in the intangible asset’sIntangible Asset'sIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. investment. It represents legal claims to future cash expected generally at a defined maturity and defined rate. The counter-parties involved in the agreement are the company that will pay the future cash (issuer) and the investors.
Disadvantages and Limitations
- Financial assets (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 accountsMoney Market AccountsMoney Market Account is the account which receives all the interests from the instruments in the money market according to the agreed-upon terms. This account is separate from that of securities account, it only accounts for the proceeds. may prevent withdrawal for months or years as per the agreement, or they are callable.
- It majorly comes with a maturity date in the contract, attempting to cash out assets before maturity calls for penalties and lower returns.
- The value of this asset is determined by the demand and supply of such assets 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.
- The measurement of financial assets cannot be done using a single measurement method. Suppose we measure 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 companies, the market price of the share is not relevant because the investor holding majority shares may not sell them.
- Every financial asset has different risks and returns for its purchaser. For instance, a car company usually has no idea of the sale of its cars, so the value of stocks of the company may increase or decrease. A bond can default as issuers may fail to pay back the par value of a bond. Even cash and savings accounts have risks associated, as inflation may have 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 such 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 such asset. Since each type of asset has some reward & risk associated with it, it’s always advisable to keep a mix of different asset types to have an optimal portfolio. It helps in the proper functioning of the organization without any dearth of assets.
This article has been a guide to what are Financial Assets and its definition. Here we discuss the importance of Financial Assets & its characteristics, advantages & disadvantages. You may also learn more about the following articles –