What are Financial Assets?

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 matter, 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 assetsTangible AssetsTangible assets are assets with significant value and are available in physical form. It means any asset that can be touched and felt could be labeled a tangible one with a long-term valuation.read more.

These are legal claims, and these legal contracts are subject to future cash at a predefined maturity valueMaturity ValueMaturity value is the amount to be received on the due date or on the maturity of instrument/security that the investor holds over time. It is calculated by multiplying the principal amount to the compounding interest, further calculated by one plus rate of interest to the period’s power.read more and predetermined time frame.

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Types of Financial Assets

These all can be classified into different categories according to the cash flow features associated with them.

#1 – Certificate of Deposit (CD)

This financial asset is an agreement between an investor (here, company) and a bank institution. The customer (Company) keeps a set amount of money deposited in the bank for the agreed term in exchange for a guaranteed interest rate.

#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.read more sold by companies or the government to raise funds for short-term projects.A bond is a legal documentA Bond Is A Legal DocumentBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period.read more that states the money the investor has lent the borrower, the amount 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 company’s ownership 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.read more 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.read more is the cash or equivalentCash Or EquivalentCash and Cash Equivalents are assets that are short-term and highly liquid investments that can be readily converted into cash and have a low risk of price fluctuation.  Cash and paper money, US Treasury bills, undeposited receipts, and Money Market funds are its examples. They are normally found as a line item on the top of the balance sheet asset. read more reserved with the organization.

#5 – Bank Deposits

These are the cash reserve of the organization with Banks in saving and checking accountsChecking AccountsA checking account is a bank account that allows multiple deposits and withdrawals. Additionally, it provides superior liquidity.read more.

#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. read more are financial assets whose value is derived from other underlying assets. These are 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.read more 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 suitable for all these assets. However, they 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.read more 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.read more on a company’s balance sheet.

#1 –  Current Assets

It contains those investment assets which are short-term in nature and are liquid investments.

source: Microsoft.com

#2 – Non-Current Assets

Non-Current assets like shares of other companies or debt instruments held in the portfolio for more than a year.

Advantages

  • 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.It gives investors 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 the 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. read more investment. It represents legal claims to future cash expected generally at a defined maturity and rate. The counterparties 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 in their 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.read more may prevent withdrawal for months or years as per the agreement, or they are callable.It comes with a maturity date in the contract; attempting to cash out assets before maturity calls for penalties and lower returns.

Important Points

  • 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 if 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 the 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 about the sale of its cars, so the value of the company’s stocks 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 impact purchasing power.

Conclusion

These are a crucial part of any organization. It always needs to have a good record of its financial assets to be put to use whenever needed, like in financial emergencies. Therefore, it is helpful to check the availability of such assets.

Every financial asset has a different but particular goal for the holder. Each has a different amount of risk associated with it. Thus, returns are also different based on risk for the purchaser of such assets. Since each type of assetType Of AssetAssets are the resources owned by individuals, companies, or governments expected to generate future cash flows over a long period. There are broadly three types of asset distribution: 1. Based on convertibility (current and non-current assets), 2. Physical existence (tangible and intangible assets), 3. Usage (operating and non-operating assets)read more 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 shortage of assets.

This article has guided what financial assets are and their definition. Here we discuss the importance of Financial Assets & their characteristics, advantages & disadvantages. You may also learn more about the following articles –

  • Financial Assets ExamplesCurrent Assets vs. Non-Current AssetsQuick Assets OverviewWhat are the Non-Performing Assets (NPA?