### Harish Jagtani Blog – 8 Types Of Accounting Equations All Business Owners Must Know

#### From Harish Jagtani’s Desk

If you are already a business owner, you should know how hard running it can be! But, if you are planning to start a new business, let me tell you there would be a lot of calculations and formulas involved that might seem especially complex if you hate maths as I do. Big businesses can hire people to do such jobs, but smaller ones would like to handle these by themselves.

We often have to do many things in life that we dislike. So, to keep your business in good shape, you can do some calculations, too. You don’t have to start taking maths classes for this, but you should learn certain critical business formulas.

Balance Sheet Equation

Total Assets = Liabilities + Equity

It basically tells you whether your business has a balanced sheet or not. The balance sheet equation, or accounting equation, is the basic equation. It creates the foundation for the double-entry accounting system. In its simplest form, it shows what your business owns, what it owes and what stake you have in the business. Assets are the things that belong to your company, while Liabilities are the obligations your company has to pay. And Equity is the value of the portion of your company that belongs to you, the owner. The total amount of the Assets must be equal to the sum of Liability, as well as Equity.

Net Income Equation

Net Income = Revenues – Expenses

Net income, or net profit, refers to the all-pervasive “bottom line”. (Note: Net income appears on the final line item, or bottom line, of your company’s income statement). Net income is the amount of profit a business has left after paying off all expenses.

Revenues are the sales or other positive cash inflows. Expenses are the costs. In the business phases, the Net income equation may show a net loss. Becoming profitable or establishing a positive Net income should be the goal of every small business.

Breakeven Point Equation

Breakeven Point = Sales – Fixed Costs – Variable Costs = 0 Profit

Breakeven Point is the point at which the total cost to run your business and the revenue it generates become equal. This means, there is no loss or gain for your small business because it is not earning profits and is neither losing. Therefore, you are at a breakeven point. Calculating your breakeven point lets you decide how much more money your business needs to generate to become profitable.

Fixed Costs are the recurring, predictable costs you must pay to conduct business. The contribution margin is the profit of a single product or service. To find the contribution margin, subtract total variable costs per unit from the sales price per unit and divide by the sales price per unit. It is: Contribution Margin = (Sales Price per Unit – Total Variable Costs per Unit) / Sales Price per Unit

Cash Ratio Equation

Cash Ratio = Cash ÷ Current Liabilities

A majority of businesses take some form of a credit to function, like mortgages and loans and so on. The Cash Ratio equation measures your company’s liquidity. In other words, it is the ability to pay off all of these liabilities right away if you have to. Cash is the amount of money you have in hand. This can include actual cash and equivalents, such as highly liquid investment securities. Current Liabilities are the current debts that a business has incurred.

Profit Margin Equation

Profit Margin = Net Income ÷ Sales

Net Income is the total amount of money your business makes after removing expenses. Sales is the operating revenue you generate from business activities. When you divide your Net Income by Sales, you get your organization’s Profit Margin. This Profit Margin reports the Net Income earned on every dollar of sales. A high Profit Margin will indicate that your company is especially healthy. A low Profit Margin could indicate that your business does not handle expenses well.

Remember that your Net Income consists of your total revenue minus the expenses you incur. If you have a high Sales revenue, but a low Profit Margin, it means you should take a look at the figures that make up your Net Income.

Debt-to-Equity Ratio Equation

Debt-to-Equity Ratio = Total Liabilities /Total Equity

The Debt-to-Equity Ratio is a solvency ratio that determines how much debt a business uses to finance its operations. In general, a high Debt-to-Equity Ratio indicates that a business has over-utilized debt to grow—or a high proportion of your company’s financing comes from debt. A high ratio may make it more difficult to secure investors or creditors. Total Liabilities include all of the costs your business must pay to outside parties. Total Equity is the amount of money you, as the owner, have invested in the business.

Cost of Goods Sold Equation

CoGS = Beginning Inventory + Cost of Purchasing New Inventory – Ending Inventory

If your business involves inventory, you must understand the Cost of Goods Sold (CoGS). CoGS is the cost of producing an item or service that your company sells. It may include materials that go into creating a product or performing a service, the labor needed, and overhead costs related to the production. The Beginning Inventory is the amount of inventory you have in hand at the beginning of the period. The Cost of Purchasing New Inventory is the amount of money you spend to manufacture your products or services. Ending Inventory refers to the remaining product you have at the end of the period.