What Do Fixed Assets Mean for a Business?
Gain a clear understanding of fixed assets, their importance to business operations, and how they affect a company's long-term financial health.
Fixed assets are tangible resources a business uses to generate income and facilitate operations over a long period. They are not intended for immediate sale but provide ongoing value, forming the underlying infrastructure that enables a business to produce goods, provide services, or manage administrative functions.
Characteristics of Fixed Assets
Fixed assets possess distinct attributes. They are long-term, expected to be used for more than one accounting period. These assets are acquired for use within business operations and are not held for resale. Their purpose is to contribute to the production of goods or services.
Most fixed assets are tangible, possessing a physical form. They are considered illiquid, meaning they cannot be easily converted into cash without disrupting operations. Fixed assets often represent a significant portion of a company’s total assets.
Examples of Fixed Assets
Fixed assets encompass a range of items that are vital for business operations across various industries. Land, for instance, is a common fixed asset used for office buildings, factories, or other operational purposes. Buildings and facilities, including offices, warehouses, and manufacturing plants, are also typical examples, providing the physical space for business activities.
Machinery and equipment, such as manufacturing tools, production lines, or specialized instruments, are fixed assets that directly contribute to creating products or delivering services. Vehicles, including company cars, trucks, or delivery vans, are considered fixed assets when used for business transportation. Office furniture, computers, and other electronic equipment also fall into this category, supporting administrative and operational functions.
Accounting for Fixed Assets
Businesses record fixed assets at their original cost, which includes not only the purchase price but also any additional expenses incurred to get the asset ready for its intended use, such as transportation, installation, or testing. Once acquired, the cost of most fixed assets, except for land, is systematically allocated over their estimated useful life through a process called depreciation.
Depreciation is an accounting method that spreads the cost of a tangible asset over the period it is expected to be used to generate revenue. This practice aligns with the matching principle, a fundamental accounting concept that requires expenses to be recognized in the same period as the revenues they help generate. By depreciating an asset, a portion of its cost is recorded as an expense on the income statement each accounting period, reflecting the asset’s wear and tear or obsolescence.
Depreciation impacts the balance sheet by reducing the asset’s recorded value over time. The original cost of the asset remains on the balance sheet, but an offsetting account called “accumulated depreciation” accumulates the total depreciation recorded to date, thereby reducing the asset’s net book value. This process provides a more accurate representation of the asset’s remaining value and avoids a significant one-time expense that would distort financial performance if the entire cost were expensed immediately upon purchase.
Fixed Assets Versus Current Assets
Distinguishing between fixed assets and current assets is important for understanding a company’s financial position and liquidity. Current assets are resources expected to be converted into cash, consumed, or used up within one year or one operating cycle of the business, whichever is longer. Examples of current assets include cash, accounts receivable (money owed by customers), inventory, and short-term investments.
In contrast, fixed assets are long-term resources intended for use over multiple years and are not easily converted into cash. The primary difference lies in their liquidity and the timeframe of their use. Current assets provide the necessary funds for day-to-day operations and short-term obligations, while fixed assets form the long-term operational foundation of the business. Fixed assets are typically listed under “Property, Plant, and Equipment” (PP&E) on the balance sheet.