Accounting relies on math for analyzing financial data, ensuring accuracy in records, and creating reports. Here’s a breakdown of key formulas and calculations used in accounting:
This is the foundation of double-entry bookkeeping:
[
{Assets} = {Liabilities} + {Equity}
]
- Assets: What the company owns.
- Liabilities: What the company owes.
- Equity: Owner's investment in the company.
To calculate profitability:
[
{Net Income} = {Revenue} - {Expenses}
]
- A positive value indicates profit, while a negative value shows a loss.
To assess earnings before operating expenses:
[
{Gross Profit} = {Revenue} - {Cost of Goods Sold (COGS)}
]
To find the sales volume needed to cover costs:
[
{Break-Even Point (Units)} = \frac{{Fixed Costs}} / {{Selling Price per Unit} - {Variable Cost per Unit}}
]
- Fixed Costs: Costs that don't change with production.
- Variable Costs: Costs that change with production.
To evaluate the profitability of a product:
[
{Contribution Margin} = {Selling Price per Unit} - {Variable Cost per Unit}
]
- Contribution Margin Ratio:
[
{CM Ratio (\%)} = \left(\frac{{Contribution Margin}} / {{Selling Price per Unit}}\right) * 100
]
To assess a company's short-term financial health:
[
{Current Ratio} = \frac{{Current Assets}} / {{Current Liabilities}}
]
- A ratio above 1 indicates good liquidity.
To evaluate immediate liquidity:
[
{Quick Ratio} = \frac{{Current Assets} - {Inventory}} / {{Current Liabilities}}
]
To measure financial power:
[
{Debt-to-Equity Ratio} = \frac{{Total Liabilities}} / {{Total Equity}}
]
- A higher ratio indicates more debt relative to equity.
To assess profitability of an investment:
[
{ROI (\%)} = \left(\frac{{Net Profit}} / {{Investment Cost}}\right) * 100
]
To allocate an asset's cost over its useful life:
[
{Depreciation Expense} = \frac{{Cost of Asset} - {Salvage Value}} / {{Useful Life (Years)}}
]
To measure how efficiently receivables are collected:
[
{Accounts Receivable Turnover} = \frac{{Net Credit Sales}} / {{Average Accounts Receivable}}
]
To calculate how often inventory is sold and replaced:
[
{Inventory Turnover} = \frac{{COGS}} / {{Average Inventory}}
]
To measure profitability per share:
[
{EPS} = \frac{{Net Income} - {Dividends on Preferred Stock}} / {{Average Outstanding Shares}}
]
For interest calculations in loans or investments:
[
{Future Value (FV)} = P * \left(1 + \frac{r}{n}\right)^{n * t}
]
- ( P ): Principal
- ( r ): Annual interest rate
- ( n ): Number of compounding periods per year
- ( t ): Time in years
To determine the value of future cash flows:
[
{DCF} = \frac{{Cash Flow}_1}{(1 + r)^1} + \frac{{Cash Flow}_2}{(1 + r)^2} + \dots + \frac{{Cash Flow}_n}{(1 + r)^n}
]
- ( r ): Discount rate
- ( n ): Number of periods
A company has ( {Revenue} = \$500,000 ) and ( {COGS} = \$200,000 ):
[
{Gross Profit} = 500,000 - 200,000 = 300,000
]
Fixed Costs = $50,000, Selling Price/Unit = $100, Variable Cost/Unit = $60:
[
{Break-Even Point (Units)} = \frac{50,000}{100 - 60} = 1,250 \, {units}
]
These formulas enable accountants to maintain financial accuracy, assess performance, and support business decision-making!