As a small business owner in Hong Kong, you may prefer to handle your own accounting, to maintain control over your own books. If so, here are some standard accounting formulas you should know. These formulas will help you understand the viability and health of your business.
Finance
7 Accounting Formulas Every Business Should Know
1. The Accounting Equation
Equation: (Assets = Liability + Owner’s Equity)
What It Means:
- Assets are all of the things your company owns, including property, cash, inventory and equipment that will provide you with a future benefit.
- Liabilities are obligations that you must pay, including things like lease payments, merchant account fees and debt service.
- Owner’s Equity is the portion of the company that actually belongs to the owner.
2. Net Income
Equation: (Revenues – Expenses = Net Income)
What It Means:
- Revenues are the sales or other positive cash inflow that comes into your company.
- Expenses are the costs that are associated with making sales.
- By subtracting your revenue from your expenses, you can calculate your net income. This is how much you’re earning, and the goal is for this to become positive (and as high as possible).
3. Break-Even Point
Equation: (Break-Even Volume = Fixed Costs / Sales Price – Variable Cost Per Unit)
What It Means:
- Fixed Costs are recurring, predictable costs that you must pay in order to conduct business. These costs include insurance premiums, rent, employee salaries, etc.
- Sales Price is the retail price you sell your products or services for.
- Variable Cost Per Unit is the amount it costs you to make your product.
- This tells you how much of your product you need to sell in order to cover your costs and start making money.
4. Cash Ratio
Equation: (Cash Ratio = Cash / Current Liabilities)
What It Means:
- Cashis simply the amount of cash you have at your disposal. This can include actual cash and cash equivalents (i.e. highly liquid investment securities).
- Current Liabilitiesare the current debts the business has incurred.
- This gives you an idea of how much cash you currently have on hand. The higher the number, the healthier your company.
5. Profit Margin
Equation: (Profit Margin = Net Income / Sales)
What It Means:
- Net Income is the total amount of money your business has made after expenses have been removed.
- Sales are the total amount of sales you’ve generated.
- This shows how much you’re making per sale. If it’s too low, it may reflect that your costs are too high, or that your business is not very healthy.
6. Debt-to-Equity Ratio
Equation: (Debt-to-Equity Ratio = Total Liabilities / Total Equity)
What It Means:
- Total Liabilities include all of the costs you must pay to outside parties, such as loan or interest payments.
- Total Equity is how much of the company actually belongs to the owner or other employees.
- This ratio shows how much of your company’s financing comes from external sources. A high number might make it more difficult to get more financing or investors.
7. Cost of Goods Sold
Equation: (Cost of Goods Sold = Cost of Materials/Inventory – Cost of Outputs)
What It Means:
- Cost of Materials/Inventory is the amount of money your company has to spend to secure the necessary products or materials to manufacture your product.
- Cost of Outputs is the total cost of the goods sold.
- This tells you if the costs you’re paying to make your product are in line with the revenue you earn when you sell it.
Even if you’re not planning to manage your own accounting, you should have a good grasp of these fundamental accounting formulas. The more knowledge you have regarding your finances, the better you can manage your business.
