Reputation and market forces do assert their influence, but it is assets that determine a company's true wealth. Holding significant economic value, assets are acquired by an individual, a company or government with the intention to generate greater economic benefits in the future. They can perhaps be compared to seeds, carefully chosen, sown, and nurtured to finally yield harvest of financial success.
Based on how quickly a resource can be converted into cash, assets can be divided into two types.
1) Current assets: This includes resources that can be easily converted into cash within a short duration of a year.
2) Non-current assets: These are resources meant to be used for the long term and are difficult to liquidate.
Fixed assets, deferred charges, intangible assets, and long-term investments collectively form non-current assets. Our emphasis in this blog will be specifically on fixed assets, exploring their characteristics, advantages, and disadvantages. We’ll delve into their critical role in the business world, providing insights to help you leverage them strategically.
What is a fixed asset?
In accounting terms, a fixed asset is generally a tangible piece of property or equipment owned by an organisation. They hold a significant value and are recorded as property, plant, and equipment (PP&E) on the balance sheet. Machinery, computers, and delivery vehicles are typical examples of fixed assets.
Key characteristics of fixed assets
Certain characteristics make an asset eligible for classification as fixed, such as:
Most fixed assets have a physical form that can be seen and touched, making them tangible. However, there are certain exceptions to this, as some depreciable intangible assets, like long-term leases or usage rights, could be treated as fixed assets for accounting purposes. Similarly, permanent land improvements, such as irrigation systems or paved roads, become part of the land itself and might be seen as fixed assets.
Fixed assets boast a useful life that goes beyond a single accounting period. They are meant to bring lasting advantages to the organisation. It's worth noting that items such as a coffee maker, despite enduring beyond a year, are considered expenses owing to their lower value, rather than falling under fixed asset classification.
Assets are regarded as illiquid if, they cannot be easily converted into cash. Their long-term nature and susceptibility to depreciation generally make them less liquid compared to current assets.
Business operations purpose
Their primary purpose is to support the daily operations of the business and aid in revenue generation, they are not meant to be directly sold to the customers or held for investment purposes.
Capitalisation and depreciation
Initially, fixed assets are capitalised on the balance sheet and subsequently they depreciate in value over their useful life.
What are some examples of fixed assets?
For ease of balance sheet reporting, examples of fixed assets can be clubbed together in following categories:
- Land - It includes real estate owned by the company for various purposes, such as agriculture, constructing offices, or manufacturing plants.
- Plant and machinery - Equipment, machinery, and tools used in the manufacturing process fall under this category.
- Buildings and facilities - Office buildings, warehouses, factories, or any other constructed structures owned by the company.
- Vehicles - All company-owned vehicles used specifically for operational needs, including cars, trucks, forklifts, and delivery vans.
- Office furniture and fittings - From desks and chairs to shelves and cabinets, this category covers all the furniture and fixtures found in an office.
- Computer equipment - Computers, servers, and other IT hardware used for various purposes within the organisation.
- Tools - This includes all specialised tools and equipment used in specific industries such as construction tools, diagnostic equipment, or scientific devices.
One thing to bear in mind is that the above examples (and their categorisation) are not applicable to all and may vary based on the industry and business. For instance, a technology company might classify servers as fixed assets, while a data centre, primarily engaged in server manufacturing, might designate the same servers as inventory.
Advantages of fixed assets
Beyond their pivotal role in business operations and income generation, fixed assets offer several other benefits, such as:
1. Financing collateral
They can serve as collateral when taking loans, making it easier for businesses to secure financing.
2. Tax benefit
Being depreciable, fixed assets offer tax advantages to businesses through depreciation deductions.
3. Monetary value
Some fixed resources, such as real estate, may appreciate over time, enhancing the company's overall financial worth. Additionally, certain fixed assets can be resold, generating income or funds for upgrades.
4. Competitive advantage
Having modern and efficient fixed assets, like cutting-edge machinery in a manufacturing facility, facilitates faster production, higher precision, and reduced downtime, hence providing a competitive edge for the company.
Disadvantages of fixed assets
1. High upfront investments
Acquisition and installation of fixed assets require substantial upfront expenses. These cash outflows can negatively impact the company's immediate cash flow and financial stability.
2. Maintenance and upgrades
Fixed assets, being regularly utilised, are susceptible to wear and tear and necessitate routine maintenance. Additionally, technological progress may render certain assets outdated, leading to the regular need for upgrades or replacements. These accumulating costs contribute to the increase in the business's overall operating expenses.
3. Storage requirements
Some fixed assets, like machinery, are bulky and require dedicated storage space, adding logistical challenges and costs to the company.
4. Financing risks
Due to their limited liquidity, turning fixed assets into cash during economic slowdowns is challenging. While they can be used as loan collateral, there's a risk of asset seizure if repayment is delayed or fails, potentially hindering company operations. Assets like real estate may also be affected by market fluctuations, impacting the business's financial value.
When should a business have more or less fixed assets
Determining whether to have more or less fixed assets requires a nuanced approach. The optimum level will vary depending on the business, industry, economic conditions, company’s financial situation, and strategic goals.
When to accumulate fixed assets?
Investing in more fixed assets is beneficial for businesses requiring a robust infrastructure, like machinery and production facilities, to meet high demand. This includes industries such as manufacturing, construction, and transportation that need heavy-duty equipment, and vehicles for functioning.
Similarly, businesses aiming to grow, improve efficiency, or those pursuing long-term strategies like infrastructure development should consider investing in fixed assets. In these cases, owning assets instead of leasing is more beneficial, as it offers more control over production quality and cost.
A company can safely invest in expensive fixed assets for growth without risking its long-term survival only if it's in a good financial position, with strong cash reserves and a healthy cash flow.
When to offload fixed assets?
It is imperative to offload fixed assets that become technologically outdated, reach the end of their useful life, or when their maintenance costs significantly outweigh their benefits. Selling or replacing such assets will be more cost-effective and efficient.
When a business undergoes a strategic shift such as a change in service offerings, existing assets might no longer be necessary or compatible. They may sit unused for extended periods, generating no income and incurring maintenance costs. Offloading them frees up capital and reduces unnecessary expense.
Some assets are more economical when leased than owned. In such cases, selling them and transitioning to a leasing model is likely the smarter choice.
During times of economic turbulence, selling fixed assets can provide a significant one-time cash inflow, which may be crucial for addressing immediate financial needs, debt repayment, or investing in critical areas.
Do fixed assets depreciate?
As we touched upon earlier, fixed assets lose value over time, in a process called depreciation. However, land is an exception to this. Depreciation involves recording a portion of the asset's cost as an annual expense, thereby reducing its value on the balance sheet. For example, consider a company buys a machine for £1,000, with a useful life of 10 years. Each year, the company would note a depreciation of £100 on its financial records.
Similarly, intangible assets such as trademarks or digital assets also experience a similar decrease in value, known as amortisation.
What is capitalisation?
When a business purchases machinery, rather than immediately expensing its cost on the income statement, they log it as an asset on the balance sheet. This process is called capitalisation. Fixed assets start off being capitalised and then gradually decapitalise as they depreciate.
How technology helps businesses better leverage their fixed assets
Effectively leveraging fixed assets is essential for businesses as it significantly influences performance, growth, and financial wellbeing. Organisations can harness various technologies, such as asset tracking software, predictive maintenance tools, and automation solutions, to optimise resource allocation, automate tasks, and ensure consistent/high-quality outputs.
Thoroughly monitoring all assets helps companies to identify underutilised or inefficient resources, presenting opportunities to optimise processes and ensure all assets contribute in the desired ways. Implementing modern cloud-based solutions for asset management, alongside data-driven decision-making and process optimisation, can further contribute to significant cost reduction through extended asset lifespan, preventive maintenance, and lower operational expenses.
How Advanced Financials can help you keep on top of your fixed assets
Effectively managing the full life cycle and depreciation of assets is a cornerstone of sound financial management.
Advanced Financials offers reliable asset management functionality. This Cloud-based accounting solution provides comprehensive support from planning to depreciation, tracking, and reporting. Seamlessly monitor your assets' entire life cycle, optimise tax savings, and trim costs by precisely pinpointing when assets will become fixed.
Read more about Advanced Financials and take full control of your business’s finances, with a single version of the truth and a unified approach across your data and functions.