If you’re a small business owner who likes to do their own bookkeeping, you’re not alone. Luckily, you don’t have to be an accountant to assess your business’ financials. Use these tried-and-true accounting formulas to quickly and accurately gauge your company’s financial health.
Accounting Formula to Help Your Business
Accounting Equation Formula
The accounting equation is the big kahuna of formulas. It’s sometimes called the balance sheet equation as well. This most basic accounting equation has only one purpose which is to show you whether your financial statements and records are accurate:
Liability + Owner’s Equity = Assets
- Liabilities are what your company owes, including regular expenses (such as your lease, accounts payable, and loan payments).
- Owner’s equity represents the money you’d have at your disposal if you liquidated all company assets (turned them into cash).
- Assets are what your company owns: cash, property, inventory, equipment, etc.
Break-even Formula
This formula shows you how much of your product or service you need to sell in order to cover your operating costs. Your break-even point is the point at which your revenue is equal to your costs. Exceed your break-even point to turn a profit. If you aren’t reaching the break-even point, your business is operating at a loss:
Fixed Costs / (Sales Price Per Unit – Variable Cost Per Unit) = Break-Even Point
- Fixed costs are your everyday, recurring expenses—such as rent, payroll, insurance premiums, and utilities.
- Sales price per unit is how much you are asking for your product or service—the selling price.
- Variable cost per unit is the cost of the materials and labor that go into creating your product/service.
Cash Ratio Formula
This formula lets you know how much cash you currently have at your disposal. As a measure of your business’ liquidity, the cash ratio helps you understand how easily your company can pay off its debts if it needs to. The higher the cash ratio, the healthier your company’s financials. A cash ratio can either be greater than or less than 1:
Cash / Current Liabilities = Cash Ratio
- Cash includes both actual cash and cash equivalents, such as investment securities that can easily become cash.
- Current liabilities are the debts that your business currently owes.
Debt-to-Equity Ratio Formula
This formula helps assess your company’s financial structure. If your debt-to-equity ratio is high, that means that most of your business’ financing comes from outside sources, like banks. A high ratio makes your business a risky investment, while a low debt-to-equity ratio makes you more attractive to banks and investors:
Total Liabilities / Total Equity = Debt-to-Equity Ratio
- Total liabilities include the money you are regularly paying to outside parties that are financing your business. They are the combined debts that your company owes, such as loans and interest rates.
- Total equity is the portion of the company you actually own.
Markup Formula
The only way to earn money on what you’re selling is to charge more than it costs for you to create and sell it. The markup percentage is the amount that you are adding to your wholesale price in order to turn a profit:
Markup Price (Selling Price – Unit Cost) / Unit Cost × 100 = Markup Percentage
- Selling price is the price your customers are paying for your product.
- Unit cost is how much it costs you to produce and sell your product.
Cost of Goods Sold Formula
Cost of goods sold, often abbreviated as COGS, refers to the direct costs of producing the products or services that your company sells. It does not represent indirect expenses like sales, marketing, or distribution costs:
Beginning Inventory + Purchases of Inventory – Ending Inventory = Cost of Goods Sold
- Beginning inventory is the total value of your in-stock inventory that you can sell to generate revenue.
- Purchases of inventory is the cost of the new inventory you purchase throughout the month.
- Ending inventory is the value of the inventory that is still available and for sale at the end of the month.
Gross Profit and Gross Profit Margin Formula
Gross profit and gross profit margin are often confused, and it’s easy to understand why. Both of these formulas gauge a company’s profitability.
Gross profit describes something commonly referred to as top-line earnings—your revenue minus your direct COGS. Gross profit margin shows your gross profit as a percentage. Both figures are telling you the same thing but in a different format:
Sales –Cost of Goods Sold = Gross Profit
- Sales refer to the total amount of money generated from selling your products or services during a certain period.
- COGS,as we’ve already noted, is the direct cost of producing your goods, such as labor and materials.
Gross Profit / Sales = Gross Profit Margin
- Gross profit, above, is the amount of money your company earns after subtracting the costs associated with producing your goods.
- Sales, as mentioned above, is the amount of money you earn selling your goods.
Net Operating Income Formula
Your net operating income tells you if your business is profitable. You’ve probably heard it referred to as a business’ “bottom line.” (Fun fact: that nickname comes from the fact that net income (or net profit/net earnings) is often listed at the bottom of your income statement.):
Revenue– Cost of Goods Sold – Expenses = Net Operating Income
- Revenue is the positive cash flow that your company earns through sales.
- COGS is the cost of the materials and labor that go into producing your goods.
- Expenses are all the other costs that help you to make a sale.
Final Thoughts
In reality, business owners know how hard it is to compile and reference all the elements needed for the formulas to work their magic.
Luckily, there’s many easy-to-use accounting software online available to small business owners who need a little help organizing their receipts, invoices, and expenses. When your bookkeeping is clean, it’s much easier to plug the right numbers into these standard accounting formulas.
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