What are Financial Assets? Definition & Meaning
Do you own anything that has some type of financial value? It could be a vehicle, a house, a lawn mower, or a piece of land, for example. What about stocks or other types of investments? There can be a lot of terms thrown around when speaking about assets and it can sometimes be confusing.
The good news? We put together this guide to break down financial assets and what they mean. Keep reading to learn more about how financial assets work, the different types, and some of the biggest advantages.
Table of Contents
- Financial assets are mainly assets that are tied to having ownership or contractual claims to an underlying tangible asset.
- Financial assets are considered high liquidity. They’re able to be sold easily but they also have the potential to lose value over extended periods.
- Cash, certificates of deposit, bonds, stock equity investments, mutual funds, and accounts receivable are all considered to be financial assets.
What Is a Financial Asset?
When you think of an asset, the first thing that comes to mind is likely a physical form of possession like property, inventory, or land. Because the traditional definition of an asset is an item of value that you own. Those types of assets have inherent value tied to them.
In comparison, financial assets aren’t always tangible. They’re mainly assets that are tied to having ownership or contractual claims to an underlying tangible asset. Instead of having inherent value, their value is tied to the supply and demand of the market and how much risk is associated with them. These types of assets might include:
- Investment portfolios
- Stock equity
- Bank deposits
- Accounts receivable
The most common type of financial assets are retirement investments and demand deposit accounts. Simply put, a financial asset consists of ownership rights or contractual rights to an underlying asset like a company, real estate, or commodity.
How Financial Assets Work
To understand how a financial asset works, it’s helpful to understand what the other types of assets are along with what’s considered a financial asset. There are multiple types of assets and a financial asset is just one of them. An asset falls into one of three categories:
Real assets are physical possessions like land, real estate, or commodities. It’s the one most people are familiar with. Intangible assets would be valuable possessions that aren’t physical such as your intellectual property, a trademark, copyright, or patent. Although they aren’t physical, they still hold value and ownership can be established. Financial assets are almost a combination of the two.
Financial assets get their value from a contract or other agreement that establishes an ownership claim over a real asset. Most of these assets don’t have a set value until they’re liquidated and turned into cash. They come in several forms and each comes with certain advantages and disadvantages.
- Cash and cash equivalents: Cash and its equivalents are considered the safest asset. The accounts the cash is stored in are backed by the FDIC and the value is consistent. It could be within a certificate of deposit, money market account, or savings account. Each one provides monthly statements that confirm the value no matter the type of deposit account.
- Stocks: Owning stocks of a company makes you part owner of that company. Your percentage of ownership is determined by how many shares of the stock you own compared to how many shares were issued. Depending on the type of stocks you may also be entitled to dividend payments. These are considered high risk, but there’s potential for high reward.
- Bonds: Bonds are an investment that entitles the owner to the repayment of the bond plus interest once the bond reaches its maturity date. It’s similar to a loan granted to a company from an individual.
- Accounts receivable: Accounts receivable are considered an asset based on the amount of money expected to be received by a company.
The commonality between all of the above-mentioned assets is that they would be considered a high liquidity financial instrument. They all gain value from an established contractual claim. Although these liquid assets aren’t tangible, the value attached to the financial instrument is still very real.
Advantages of Financial Assets
Financial assets come with several advantages that you won’t find with real or intangible assets.
- High liquidity makes it easy to convert the asset into cash when an emergency hits.
- Bank deposits are protected by the FDIC by up to $250,000 in case the bank fails.
- Some financial assets can increase in value. Stock prices might rise, or money market deposit accounts gain interest from the bank or financial institution.
In comparison, a physical asset like land or property is considered an illiquid asset. If you were interested in liquidating a piece of real estate it must be listed, contracted, and then sold. That could take months. Meanwhile, trading in stock equity might take up to two business days.
Disadvantages of Financial Assets
Holding liquid assets allows for some flexibility, better control of assets, and added protection. There may even be a slight return on your investment funds. However, there are downsides to keeping financial assets as well. They include:
- The price you pay for high liquidity is often a lower return on investment. Checking accounts, money market accounts, and savings accounts offer minimal amounts of interest on your deposit.
- Keeping bank deposits amounts above $250,000 in one bank could mean there’s a potential for loss if the bank fails.
- High liquidity doesn’t apply to investments with low demand such as penny stocks or specialty stocks.
- Financial asset values are dependent on the supply and demand of the market it’s based in. For example, if you’ve invested in stocks for the oil and gas industry, but the oil and gas market crashes then you might take a loss on your investment.
Overall, financial assets are useful when including high liquidity assets as part of your strategic investments plan. Several monetary instruments are considered liquid assets including cash, equity instrument, bonds, and receivables. They aren’t physical assets but they have a value that’s closely tied to real assets through a claim of ownership or contracts. The value of financial assets depends on the supply and demand that influence investments and affects the price of the underlying asset it’s tied to.
Financial Asset FAQs
Financial assets are important because they allow for faster cash conversion compared to real or intangible assets which are more illiquid investments. This provides a financial cushion in the event of an emergency or pressing financial needs. Assets that are less liquid such as real estate require a longer time frame for funds to become available.
They can be. Financial assets such as stocks, retirement accounts, and bonds would be considered investments. Cash and some of its equivalents would not.
Cash is considered to be the safest financial asset for the average investor.
A tangible asset holds intrinsic value and is a physical possession. Financial assets are non-physical and their value comes from the contracts and agreements that grant a form of ownership over a tangible asset.
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