Being great in math is not a prerequisite for being a successful businessperson, but there are business formulas that should be understood and kept handy in order to stay apprised of the financial strength and condition of your small business. Especially if your company doesn’t have an accountant or work closely with one, you should be able to access the correct business formula to understand and analyze the financial health of your business.
Accounting Equation
The accounting equation is also known as the ‘balance sheet equation’ and the ‘basic accounting equation’, and it shows how to simply balance a balance sheet. This is probably the most basic business equation and is as follows:
Assets = Liabilities + Equity
Assets are anything of value your business owns, liabilities are what your business owes, and equity represents the ownership or contributions you have in your business. It’s a good formula to know because you can quickly determine if any transactions have overlooked and not been recorded. If the total assets don’t add up to equal the equity plus liability, you know there has been a mistake somewhere.
The accounting equation can also be rearranged to find equity. That in question would be:
Equity = Assets – Liabilities
This is a good way to find a quick assessment of the health of your business. If your business’s assets (cash, accounts receivable, inventory, equipment, vehicles, etc.) are worth $100,000 and your liabilities (accounts payable, wages payable, income taxes payable, customer deposits, etc.) total $25,000, then you know that your equity equals $75,000. Not bad! That is good news for your business, and it indicates that it is in good shape and profitable.
Net Income
The net income formula is another way to help you determine the health of your business by determining its profitability. Also known as the bottom line, the net income formula is:
Net Income = Income – Expenses
This simple formula will tell you the difference between your income and expenses to determine your business’s net profit (net income). If it is a positive number, your business is profitable. And if it is negative, your business is operating at a net loss. To find net income, you’ll need to know your income (total business revenue including sales profits, received rents, received fees, etc.) and your expenses (loan payments, operating expenses, payroll, advertising, utilities, rent, etc.). Suppose your business has a revenue of $50,000 and expenses of $30,000. The net income would be $20,000. It’s not uncommon for new businesses to show a net income loss for the first couple of years before showing a net income profit.
Cost of Goods Sold
The Cost of goods sold (COGS) formula will help determine what your business spends to produce products or provide services in a specific time period. It looks like this:
Cost of Goods Sold = value of beginning inventory + inventory purchases during a period of time – value of ending inventory
The COGS includes the cost of materials and labor directly necessary to produce goods and does not include indirect expenses such as overhead, sales and marketing, and distribution costs. The formula is useful to help determine gross profit margin and prices of products and services. A high COGS will result in a low-profit margin.
Using the cost of goods sold formula, suppose your business has a beginning inventory of $10,000 during the first quarter. You, the business owner, will spend $15,000 during the quarter, and your ending inventory at the end of the quarter is $5000.
$10,000 + $15,000 – $5000 = $20,000 (Cost of Goods Sold)
Once the cost of goods sold is determined, it can be plugged into another formula (Gross Profit Margin) along with the cost of goods sold and total sales to determine your gross profit (more on that later). COGS can also be used to determine COGS Ratio and Gross Markup.
Break-Even Point
The break-even point will tell you how many products or services your company needs to sell in order for your businesss’ total costs to equal total revenues. At this point, there is neither net loss nor net gain, and the cost of production equals product revenues. The breakeven point formula is:
Break-Even Point = fixed costs / gross profit margin (sales price per unit – variable cost of unit production)
Suppose your fixed costs (rent, utilities, payroll, overhead, etc.) equals $15,000, your sales price per unit is $30, and the variable cost of your production is $15.
Break Even Point = $15,000 / ($30 – $15)
The break-even point of your business would be 1000 units sold in a period, or you could post it as needing $30,000 (1000 units x $30) worth of sales to break even in a specific time period.
Profit Margin
What is the goal of nearly every business? To make a profit, of course. The profit margin formula is the ratio of your business’s profits (sales – expenses) divided by the business’s revenue that is then multiplied by 100. It is a ratio that compares profit to sales to determine how much revenue you’ll retain after deducting expenses.
Profit Margin = (Net Income / Revenue) X 100
A high-profit margin indicates the healthy profitability of a business and shows total revenue after accounting for all expenses and income sources.
In a quarter, a business might have a net income of $10,000 and revenue of $50,000. Using the profit margin formula:
Profit Margin = ($10,000 / $50,000) x 100
The profit margin is 20%, meaning that the profit of a business is 20% of its revenue. A larger profit margin can be obtained by either increasing sales or decreasing the cost of sales.
Other Business Formulas
There are many other helpful business formulas that are useful for a variety of situations. A few of the more common ones are listed below:
Inventory Shrinkage formula
Inventory Shrinkage = [(Recorded Inventory – Actual Inventory) / Recorded Inventory] X 100
Current Ratio
Current Ratio = Current Assets / Current Liabilities
Debt-to-Equity Ratio equation
Debt-to-equity ratio = total liabilities ÷ total equity
Markup formula
Markup Percentage = [(Revenue – COGS) / COGS] X 100
It is advantageous for owners and management businesses to familiarize themselves with these business formulas in order to accurately analyze the health and profitability of the business. If something is not working, then changes need to be made. But without the use of these business formulas and a little investigation, a company might be unnecessarily losing out on potential profits. Using these formulas could improve your business and fatten your business’s bottom line.