Running a full-scale business comes with various daily duties as well as long-term responsibilities. Of course, outsourcing a few business responsibilities, such as accounting, can give you more time to prioritize other business tasks. But as a business owner, you should know basic accounting equations in order to have a greater understanding of your company’s financial position. Here are a few equations that every business owner should know:
- Total Assets = Liabilities + Equity
This formula can be referred to as your basic accounting equation. Assets are all things of value that your company owns, such as property, cash, accounts receivable, or inventory that provide your business benefit. Liabilities are defined as your company’s debts. This can include rent, account fees, or accounts payable. Finally, equity is the portion of the company that belongs to the owner.
- Net Income = Revenue – Expenses
Your revenue is the profit your company gains through sales or other positive cash inflow. Expenses are your company’s costs. Expenses subtracted from your revenue can show you how much you have earned and calculate your net income.
- Sales – Fixed Costs – Variable Costs = $0 Profit or Break-Even Point
Fixed costs are the recurring costs that your business pays, such as rent or paying employee salaries. On the other hand, variable costs can change depending on factors like production or credit card fees. If the amount of money you make in sales minus fixed costs and variable costs equals $0, that means your business breaks-even for the month.
- Cash Ratio = Cash / Liabilities
Cash refers to the amount of cash you have at your disposal, while current liabilities are your debts. This ratio reflects the health of your company. A higher number signifies that your business has more cash than debts.
- Profit Margin = Net Income / Sales
Dividing your net income by sales determines your business’ profit margin. Your profit margin shows the net income earned on each dollar of sales. Similar to cash ratio, this equation can be used to show how healthy your company is, where a higher profit margin indicates your business is in a healthy position and handles expenses well.
These basic accounting equations can serve as a foundation to help you better understand the financial position of your business as well as monthly reports. As much as it is important to understand the basics, it is also vital to keep accurate books and financial statements. Outsourcing your bookkeeping and accounting can help you reduce financial errors and prepare you for taxes. Visit our team at Bakersmith Bookkeeping Group for guidance and more information!