What are Fixed Assets?
Fixed assets refer to long-term tangible assets that are used in the operations of a business. This type of asset provides long-term financial gain, has a useful life of more than one year, and is classified as property, plant, and equipment (PP&E) on the balance sheet.
Key Characteristics of a Fixed Asset
The key characteristics of a fixed asset are listed below:
1. They have a useful life of more than one year
Fixed assets are non-current assets that have a useful life of more than one year and appear on a company’s balance sheet as property, plant, and equipment (PP&E).
2. They can be depreciated
With the exception of land, fixed assets face depreciation to reflect the wear and tear of using the fixed asset.
3. They are used in business operations and provide long-term financial gain
Fixed assets are used by the company to produce goods and services and generate revenue. They are not sold to customers or held for investment purposes.
4. They are illiquid
Fixed assets are a non-current asset on a company’s balance sheet and cannot be easily converted into cash.
Importance of Fixed Assets
Fixed assets are crucial to any company. Apart from being used to help a business generate revenue, they are closely looked at by investors when deciding whether to invest in a company. For example, the fixed asset turnover ratio is used to determine the efficiency of fixed assets in generating sales.
Companies that more efficiently use their fixed assets enjoy a competitive advantage over their competitors. An understanding of what is and isn’t a fixed asset is of great importance to investors, as it impacts the evaluation of a company.
Examples of Fixed Assets
- Buildings and facilities
- Vehicles (company cars, trucks, forklifts, etc.)
- Computer equipment
Although the list above comprises examples of fixed assets, they aren’t necessarily universal to all companies. In other words, what is a fixed asset to one company may not be considered a fixed asset to another.
For example, a delivery company would classify the vehicles it owns as fixed assets. However, a company that manufactures vehicles would classify the same vehicles as inventory. Therefore, consider the nature of a company’s business when determining fixed assets.
Relevance to Financial Statements
A fixed asset has certain implications on a company’s financial statements:
A fixed asset is capitalized. When a company purchases a fixed asset, they record the cost as an asset on the balance sheet instead of expensing it onto the income statement. Due to the nature of fixed assets being used in the company’s operations to generate revenue, the fixed asset is initially capitalized on the balance sheet and then gradually depreciated over its useful life. A fixed asset shows up as property, plant, and equipment (a non-current asset) on a company’s balance sheet.
For example, a company that purchases a printer for $1,000 would record an asset on its balance sheet for $1,000. Over its useful life, the printer would gradually decapitalize itself from the balance sheet.
With the exception of land, fixed assets face depreciation. This is to reflect the wear and tear from using the fixed asset in the company’s operations. Depreciation shows up on the income statement and reduces the company’s net income.
For example, a company that purchases a printer for $1,000 with a useful life of 10 years and a $0 residual value would record depreciation of $100 on its income statement yearly.
Statement of Cash Flow
When a company purchases or sells a fixed asset with cash, that is reflected in the investing activities section of the cash flow statement. Purchases of fixed assets are an outflow of cash and are categorized as “capital expenditures”, while the sale of fixed assets is an inflow of cash and is categorized as “proceeds from the sale of property and equipment.”
For example, a company that purchases a printer for $1,000 using cash would report capital expenditures of $1,000 on its cash flow statement.
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