What are Tangible vs. Intangible Assets?

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Tangible assets are the backbone of your company because they help you produce goods and services. For example, if you own a pizza restaurant, you’ll need a pizza oven and kitchen equipment.

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On the other hand, intangible assets may not have a physical form, but they add value to your company’s future worth. 

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But how will they help me run my company and generate cash if they're intangible?

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Good question. Consider brand reputation, which is an example of an intangible asset. You can’t see or touch it, but it significantly improves customer trust, retention, and brand advocacy, leading to more sales.

Tangibles vs. Intangibles: Which Asset Is Better?

While tangible assets help you run your business on a day-to-day basis, intangible assets enable you to grow it. 

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According to McKinsey & Company, companies that invest more in intangibles outperform their peers. And in industries such as retail and food services, where competitive advantage is based on intangibles such as customer relationships, you can beat the competition simply by giving equal importance to intangibles. 

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What this means is that you should aim for both tangibles and intangibles to succeed. With that in mind, let’s look at the different types of tangible and intangible assets to understand their differences further. 

What Are the Different Types of Tangible Assets?

You can typically group tangible assets into current and fixed assets.

Current Assets

Current assets (or short-term assets) are items you can expect to turn into cash or sell within one year. They’re like a glass of water your company can “drink” if it gets thirsty for cash, so you can run your business without borrowing money. 

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That's why you can call them liquid assets, as you can quickly liquidate them (sell them on the market). 

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While cash is the most obvious current asset, it’s not the only one. Other examples include:

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• Cash equivalents: These are short-term investments with a maturity (when you get the full return on your investment) of 90 days or less—for example, short-term government bonds.
• ​​Marketable securities: These are investments with a maturity of one year or less. Examples include bonds, mutual funds, and stocks. 
• Inventory: Your raw material or supplies are your current assets, as you can sell them on the market to get cash. 
• Accounts receivable: These refer to payments due from your customers or other businesses. For example, a pizza shop might have dues from delivery platforms such as Uber Eats. 
• Prepaid expenses: If you have paid for any services or goods but haven’t gotten them yet, you can count them as an asset, as you can still refund them. 

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Once you've recorded these short-term assets on the balance sheet, you can add them up:

Total Current Assets = Cash + Cash Equivalents + Marketable Securities + Inventory + Accounts Receivable + Prepaid Expenses

For example, suppose a pizza shop has the following finances:

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• Cash and short-term Investments: $50,000
• Total accounts receivable: $5,000
• Inventory: $20,000
• Prepaid Expenses: $2,500 

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The pizza shop’s total current assets would be $77,500.

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You can use this to calculate liquidity ratios, which help you understand your company's financial health. That way, you’ll know if your business can meet its short-term financial needs.

Fixed Assets

Fixed assets (also called long-term or non-current assets) are physical items like machines that help you run business operations. You probably have at least one fixed asset if you own a business. 

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The three most common types of these long-term assets are property, plant, and equipment (or PPE). For example, the fixed assets of a pizza shop might include a pizza place (property), kitchen (plant), and pizza oven (equipment). 

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Most fixed assets depreciate (decrease in value) over time—except for real estate and land that hold or increase in significant value. Therefore, you need to account for that on your company’s balance sheet.

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For example, suppose you buy a new pizza oven worth $25,000—not a cheap investment—for your business. If you write off the entire cost of the pizza oven in the year you buy it, it’ll throw off your income statement. You’ll have higher than usual expenses and a lower profit.

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However, you can leverage depreciation by spreading the cost over the asset’s useful life. So, rather than deducting the entire $25,000 in the first year, you can spread that cost over five years and deduct $5,000 every year.

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That way, the company's expenses will become consistent and show the real cost of the assets. 

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You also benefit from distributing the tax savings of the pizza oven. Instead of taking a significant tax deduction in one year, you deduct $5,000 in expenses each year for five years.

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Fixed assets depreciated over time appear on the asset column of the balance sheet and in the Depletion, Depreciation, and Amortization (DD&A) section of the income statement.

What Are the Different Types of Intangible Assets?

Similar to tangible assets, you can also divide intangible assets into two categories: Identifiable and unidentifiable intangible assets.

Identifiable Intangible Assets

Identifiable intangible assets lack a physical presence, but you can separate them from your business, and buy or sell them. Examples include intellectual property such as trademarks, patents, copyrights, algorithms, and computer software. 

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Identifiable intangibles typically add value to your business over the long term. But they can exist without your business, and you can sell them as assets to another company. 

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For example, Pizza Hut had a patent for a pizza sauce dispensing device. It filed the patent in May 2000, which helped it improve productivity among employees. While the patent has expired, Pizza Hut could’ve sold it to another company while it was active. 

Unidentifiable Intangible Assets

On the flip side, you can’t buy or sell unidentifiable intangible assets since you can’t separate them from your business. Examples include goodwill, brand name, client relationships, and brand reputation.  

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You can't quantify these types of assets, and their lifespan is limited. But they indirectly contribute to your company's economic value. 

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For example, your brand reputation and customer relationships are only valuable if you maintain them and continue providing quality products and services. However, they generate repeat business for your company. 

How To Value the Intangible Assets of Your Business?

You can sit back and look at your business's financial statements to estimate its value. But that would be undervaluing your company since those statements include tangible assets but don’t include your intangibles.

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Valuing your tangible assets is pretty simple: Look at the asset's cost, depreciate it if needed, and it’s done!

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But since intangible assets are—well, intangible—they're challenging to value.

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The good news is that, although difficult, you can determine the value of your intangibles using their income generation, replacement cost, or market value.

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Let’s dig into each.

Income Approach

This approach values intangible assets you can link to revenue. For example, Pizza Hut could use the income approach to determine the value of their pizza sauce dispensing device patent.

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Pizza Hut could look at the extra income (or cost savings) the pizza sauce dispensing device brought and the maintenance fees they had to pay over the patent period to estimate how much their patent was worth.

Cost Approach

While the cost approach is typically used for tangible assets, you can also use it to value intangibles like computer software.

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The substitution principle is the basis for this approach. 

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Ask yourself, "How much will it cost me to replace this asset with another one like it?" If it's computer software, you can find that out by comparing different prices of similar software.

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That way, you can know how much it would cost if anything happened to your software and you needed to replace it.

Market Value Approach

Or you can rely on the intangible asset’s market value.

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To find the market value of an intangible asset, monitor your competitors and see if they've publicly sold a similar intangible asset. 

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For example, you may find that a business competitor sold a patent to another company. From that transaction, you might determine the value of a similar patent you own.

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Acquire Both Tangibles and Intangibles to Scale Your Business

Your business needs both tangible and intangible assets to succeed in the short and long term. 

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Accounting for intangibles on financial statements can be challenging since their value fluctuates much more than tangibles. That’s why it’s essential to calculate your net tangible assets—total physical assets minus all liabilities and intangible assets.

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That’ll help you estimate the risk your business carries—especially its liquidity and solvency (ability to pay debts). You can also use it to access financing to meet your future goals.

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For instance, if your business has total assets of $500,000, intellectual property worth $50,000, and total liabilities of $75,000, your business’s net financial assets will be $375,000 ($500,000 - $50,000 - $75,000).

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In short, tangible assets will help you run your business and deliver quality products and services, while intangible assets will help you grow.

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Now that you know all about tangibles and intangibles, all that’s left to do? Make sure you’re building up both types of assets!