What is an Asset and a Liability?

What is an Asset and a Liability?

Can Assets and Liabilities be explained in a Simple way that even a sixth grade student can understand?

The answer is ‘Yes’!

Yes, there is a simple way to understand assets and liabilities.

The concept has been simplified long time back, in the year 1997, by Robert Kiyosaki.
Those who have not heard about him, he is the famous author of the BEST SELLER – Rich Dad Poor Dad.

I am not good with numbers. Finance is not my favourite subject. But when I read the book Rich Dad Poor Dad, the definition of Assets and Liabilities was engraved in my mind for ever.

Here is the definition he uses to simplify and teach the concept of assets and liabilities in his book Rich Dad Poor Dad.

ASSETS: Something that puts money in your pocket on a regular basis. Say every month. 

LIABILITIES: Something that takes away money from your pocket on a regular basis. Say every month.

How simple can one get?

Isn’t it written in simple and plain English that can be understood by a sixth grade student?

Let’s dive a bit deep to see if we can relate it to our daily lives.

Let us take an example to understand assets and liabilities.

First let us look at...

LIABILITIES

Say, you decide to buy the latest branded smart phone. The smart phone costs Rupees Seventy Thousand Only.

You don’t have cash to pay for the smart phone. You take up a loan and agree to pay the finance company a fixed EMI every month.

Now you are the proud owner of your dream smart phone.

In addition what you have done is you have triggered an auto debit mechanism that will take away a fixed amount from your bank account on a fixed date.

Every month on that fixed date your account is debited with the EMI you had agreed to pay for your smart phone.

Now link your smart phone to the definition of Liability.

LIABILITIES are something that takes away money from your pocket on a regular basis. Say every month.

Your smart phone has become your liability.

Can you see the connection?

Let’s take another example.

Say, you have two cars. But unfortunately you are not using the second car much. In fact it remains parked in front of your home for around 20 days in a month. Over and above that you have a loan running on the car. Every month your account is being debited for a fixed amount against the payment of your car.
You dread paying that money as it is creating a hole in your pocket one month at a time.

Not a good position to be In, right?

In the above scenario what you have on your head is a huge LIABILITY.

Now, can you relate to the definition of Liability?

Your second car has become your Liability that is taking away money from your pocket every month.

ASSETS

Say you have something that you can rent out to people for a fixed monthly income.

Let us assume you have a shop that is lying vacant.

You get into a deal with a small businessman and rent out your vacant shop to him. He promises to pay you a fixed income every month.

Here is what happens.

You are not involved in the businessman’s business. You don’t have to work for him. You don’t care whether his business is successful or not. In fact you are busy living your own life.

Yet till the time period that businessman is using your shop he will pay you the rent on the fixed day every month.

Now link your shop to the definition of asset.

ASSETS are something that puts money in your pocket on a regular basis. Say every month.

Your shop has become your asset.

Can you see the connection?

Now let’s take the second example of the two cars that was a LIABILITY, and see if we can convert the second car into an ASSET.

Let us suppose you decide to do something about your second car.

The idea of selling your second car too crossed your mind.

But before you sell it you want to look at other possibilities.

You look around and find that there are lots of private cars plying in your city catering to pickup and drop.

You go deep into it and do some research. You ask few questions and maybe even interview a driver of the private car.

Suddenly an idea strikes you!

You decide to rent out your second car to a company that is in the business of transporting people in and around the city.

You negotiate a monthly deal with the company.

From next month onwards you start getting a monthly payment in your bank account, thanks to your second car.

What you have done is, you have knowingly converted your liability into an asset.

You monthly EMI is still on. But now that EMI is being paid by your second car. Your second car is taking care of itself.

Even if the monthly income you are receiving is not enough to cover the entire amount that goes out in EMI,  at least it will reduce your financial burden.

Once the EMI is cleared, the car will become free and will become an earning member of your family.

In short it will become an asset.

So by being a bit enterprising and thinking out of the box you were able to covert your liability into an asset.

Isn’t that cool?

In Conclusion 

Today, Assets and Liabilities have become an integral part of an individual’s living.

It’s not that Assets are good and Liabilities are always bad.

It’s all about being aware of what we are taking on.

Most of us buy liabilities and think it’s an asset. The reason being not able to understand the simple definition of what are Assets and what are Liabilities.

Become financially smart and take wise financial decision. In the long run you will thank yourself.

If you would like to grab a copy of "Rich Dad Poor Dad" by Robert Kiyosaki, then click on the link below (affiliate link).

How well do you understand Assets and Liabilities? 

Do let me know in the comments below.