This writing is informed by representing thousands of business owners; additionally, the best data comes from my first-hand conversations with business owners and their leadership team.
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What business formulas do I need to know?
It takes work to keep a business performing at its best. To keep your company in good condition, you should know a few key formulas. Yes, this involves math. While that doesn’t sound fun, you luckily don’t have to know a million equations or become a calculus whiz. However, you will have to learn some basic business formulas.
Even if you are not an accountant, you should have the ability to gauge your company’s financial health.
Net income formula
First, let’s take a look at the net income formula. This will reveal the difference between your expenses and income. This is also referred to as net earnings, net profit, or business bottom line. If a company’s net income is negative, it is called a net loss.
It is bad to have a negative net income since it means a company has more expenses than income. However, when a business is brand new, it is normal to have negative net income until the break even point.
To calculate net income, you will need to know both your company’s revenue and expenses over a certain period of time. Tally up the company’s expenses. This includes payroll costs, operating expenses, and business loan payments. Once you have these numbers ready, you can use the below formula:
Revenue – Expenses = Net Income
So, what is the importance of net income? Well, you need to know if your company is making money or losing it. The answer to that question will tell you whether to cut costs or invest more in marketing. It is also necessary to report net income on the company’s income statement.
Example of Net Income
Let’s say that over a certain time period, you make $30,000 in revenue. Your expenses are $35,000.
Net income = $30,000 – $35,000
Net income = -$5,000
Your company has a net loss of $5,000.
Accounting formula
The accounting equation can help you determine whether your balance sheet is in order. Specifically, it tells you how much of your assets are supported by debt vs. equity. To use this equation, you will need your company’s liabilities, assets, and equity.
A business asset is a valuable item that your company owns. A liability is a debt that you owe. Business equity, meanwhile, is the amount of ownership you have in the company.
The accounting equation is as follows:
Liability + Equity = Assets
You have a problem if your assets do not equal the sum of your equity and liabilities. It’s possible you forgot to write down a sale. If your accounting equation is unbalanced, review your books for any red flags.
The accounting equation can also tell you what your company would have left over if you paid your debts using your assets. A simple tweak of the formula can do this:
Equity = Assets – Liability
Example of Accounting Equation
As the owner of a company, you have equity worth $15,000 and liabilities worth $10,000.
Assets = $10,000 + $15,000
Assets = $25,000
Your assets have to be worth $25,000.
Cost of goods sold formula
If your small business is spending a lot on producing services or products, you may have a low profit margin. To figure out how much you’re spending to make services or goods, use the cost of goods sold formula. This is otherwise known as COGS.
COGS = Beginning Inventory + Purchases – Ending Inventory
To assign prices and calculate income, you need to know your COGS.
Example of COGS formula
As a business owner, you have a starting inventory worth $5,000. You spent $6,000 over a certain period. Your final inventory is $2,000.
COGS = $5,000 + $6000 – $2,000
COGS = $9,000
Your cost of goods sold is $9,000.
Break even point formula
When a company’s total sales match total expenses, it has reached the break even point. The break even point is when you do not make a profit or endure a loss. The break even point formula can tell you how many products you need to sell to reach this point. To use this formula, you need to know your company’s variable and fixed costs. Also, you must note your sales prices per unit.
Break Even Point = Fixed Costs / (Sales Price Per Unit – Variable Costs Per Unit)
Example of break even point formula
Let’s say you’re the owner of a bakery. You want to know how many bagels you need to sell every month to break even. A bagel costs $3. You have fixed costs every month worth $2,000. Your variable costs per unit are $1.50.
Break Even Point = $2,000 / ($3 – $1.50)
Break Even Point = $1,333.33
To break even, you need to sell about $1,333 bagels every month.
Return on investment formula
How do you know if you are making smart investments? A wise use of money is when you get more than what you paid. The return on investment formula, or ROI, can tell you how well your investments are doing.
To find ROI, use this formula:
ROI = [(Investment Gain – Cost of Investment) / Cost of Investment] x 100
Example of ROI formula
Let’s say you invest $4,000 into your marketing strategy. This strategy results in an investment gain of $6,000. How successful was this investment?
ROI = [($6,000 – $4,000) / $4,000] x 100
ROI = 50
Your return on investment is 50%. Not bad!
Profit margin formula
If your company is making a profit, how does it compare to your revenue? To figure out what percentage of revenue you keep after expenses, you the profit margin formula.
Profit Margin = (Net Income / Revenue) x 100
Ideally, you want high profit margins. Higher profit margins mean greater earnings.
Example of profit margin
In a month, your net income is $3,000. Your revenue is $7,000.
Profit Margin = ($3,000 / $7,000) x 100
Profit Margin = 43%
Your profit margin is 43%, which means you keep 43 percent of your company’s revenue.
The current ratio
Which is greater, your assets or liabilities? Let’s check! To compare your current assets and current liabilities, use the current ratio.
The valuable products that your company possesses and can turn into cash in less than a year are known as current assets. Similarly, your debts that are due within a year are considered current liabilities.
Divide your current assets by your current liabilities to determine your current ratio:
Current Assets / Current Liabilities = Current Ratio
The result displays the amount that your assets exceed your liabilities. You should have a current ratio larger than one. You have more current liabilities than assets if your current ratio is less than one.
Example of current ratio
You determine that you have $10,000 in current assets after adding up all of your holdings. Additionally, your liabilities total $10,000.
$10,000 / $10,000 = the current ratio.
Current Ratio = 1
You have sufficient assets to meet your current liabilities if your current ratio is 1.
Markup equation
You can use the markup formula to help you determine the costs of your products if you need assistance. The markup percentage indicates the difference between the selling price and the cost of your offerings.
A larger profit margin may result from a higher markup. But keep in mind that margin and markup are not the same.
Use this algorithm to determine your markup percentage:
[(Revenue – COGS) / COGS] X 100 = Markup Percentage
To determine your selling price, you can alternatively multiply the cost of your good or service by a markup percentage of your choice. Use the following formula to get your selling price using markup:
Markup Percentage x COGS + COGS = Selling Price Using Markup
An example of markup
Assume you charge $700 for workstations. The desks cost $300 apiece to construct. How much of a markup do you have?
[$700 – $300) / $300] X 100 = Markup Percentage
133.33% is the markup percentage.
Your desks have a 133.33% markup.
Let’s now calculate the price at which you could sell your desks if you decided to mark them up by 70%.
$300 X 0.70 = Selling Price Using Markup + $300
$510 is the selling price after markup.
If you were to employ a 70% markup, you would have to sell your desks for $510.
The formula for inventory shrinkage
Is the inventory at your company lower than when you first started? If so, you’re losing or shrinking your inventory. A small amount of shrinking is typical, but too much can be concerning.
Use the inventory shrinkage formula to determine the percentage of inventory that your company is losing.
You should be aware of the appropriate amount of inventory. Additionally, you need to be aware of how much inventory you still have after it is lost to theft and other mishaps.
First, figure out how much stock you actually need. This is the total inventory value that is listed in your books. To find your recorded inventory, deduct the cost of products sold from the inventory.
The formula for inventory shrinkage is:
[(Recorded Inventory – Actual Inventory) / Recorded Inventory] X 100 = Inventory Shrinkage
It is preferable to have a smaller inventory shrinkage percentage.
Example of inventory shrinking
You have 500 lightbulbs listed in your inventory. You had 375 lightbulbs after an awful event that broke quite a few of them. What percentage of your inventory is shrinking?
Inventory Reduction is equal to [(500–375) / 500] X 100.
The result is a 25% decrease in inventory. Shrinkage cost you 25% of your inventory.
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