8 accounting equations to know for small business success.

Myranda Mondry, Senior Content Creator at Intuit

Running a small business takes a lot of guts, a lot of work, and a lot of heart. But who knew there would be so much math?

Fortunately, you don’t have to be a math whiz to be a successful entrepreneur. Even though running a business requires solving occasional financial equations, they’re not complex -- and you’re never more than a click away from a calculator. Here are eight of the most common accounting equations and how to solve them.

1. Balance sheet equation (the accounting equation).

The balance sheet equation, or accounting equation, is the most fundamental equation. It builds 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. It looks like this:

Total Assets = Liabilities + Equity

Assets are the things your company owns. Liabilities are the obligations your company must pay. And equity is the value of the portion of your company that belongs to you, the owner. The dollar amount of the assets must equal the sum of liability and equity.

2. Net income equation.

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 all expenses. The net income equation looks like this:

Net Income = Revenues - Expenses

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

3. Breakeven point equation.

The breakeven point is the point at which the total cost to run your business and the revenue it generates are equal. In other words, there is no loss or gain for your small business because it’s not earning profits, but it’s not losing money either. Thus, you’re breaking even.

Calculating your breakeven point allows you to determine how much more money your business needs to generate to become profitable. The equation looks like this:

Breakeven Point = Fixed Costs / Contribution Margin

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 sales price per unit and divide by sales price per unit. It looks like this:

Contribution Margin = (Sales Price Per Unit - Total Variable Costs Per Unit) / Sales Price Per Unit

4. Quick ratio equation.

In accounting, the quick ratio or cash ratio is a liquidity test. It measures your business’s ability to pay its bills with business assets that may readily convert to cash. In other words, how fast your business can pay back its debts. It’s a good formula to keep in your back pocket, especially in times of economic uncertainty. The equation looks like this:

Quick Ratio = (Current Assets - Inventory) / Current Liabilities

Current assets include things like cash and cash equivalents, accounts receivable, and stock inventory. Current liabilities are financial obligations your business owes to another party— things like loans, accounts payable, and taxes.

5. Profit margin equation.

A profit margin is the percentage of profit you keep from each sale, or how many cents of profit you keep from each dollar of sale. Understanding your profit margin can help determine whether or not your products are priced correctly and if your business is making money. Calculating your profit margin gives you a good indication of the overall health of your business. The equation looks like this:

Profit Margin = Net Income / Gross Revenue

(For info on how to calculate your net income, see no. 2.) Gross revenue or total revenue refers to the sum of all sales receipts.

A low profit margin may also indicate that your inventory is imbalanced or that your business is simply not handling expenses well. Whereas a high profit margin generally indicates a healthy company.

6. Debt-to-equity ratio equation.

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. The equation looks like this:

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

Total liabilities include all of the costs your business must pay to outside parties. Total equity is the amount of the money you as the owner have invested in the business.

7. Cost of goods sold equation.

If your business has inventory, it’s important to understand the cost of goods sold or COGS. COGS refers to the cost of producing an item or service sold by your company. The COGS may include materials used to create a product or perform a service, labor needed, and overhead costs directly related to production. The COGS formula looks like this:

COGS = Beginning Inventory + Cost of Purchasing New Inventory - Ending Inventory

Beginning inventory refers to how much inventory you have on hand at the beginning of the period. Cost of purchasing new inventory refers to the amount of money you’ll have to spend to manufacture your products or services. Ending inventory refers to the remaining product you have at the end of the period.

Understanding your COGS can help you calculate your business’s profits and determine the proper price for an item or service.

8. Retained earnings equation.

If your company has shareholders, the retained earnings equation determines how much net income you have left after you’ve paid shareholders their dividends. Understanding your retained earnings can help you make important business growth decisions, like reinvesting, financing a new product, or paying off debt. The equation looks like this:

Retained earnings = beginning retained earnings + net income - cash dividends

Beginning retained earnings are the retained earnings from the prior accounting period (the sum of all net income minus cash dividends). Net income represents the balance after subtracting expenses from revenues. It’s important to note that net income may also be net loss if your net income comes to a negative number. Cash dividends are cash payouts to those who own common stock.

Accounting equations in use.

If math isn’t your cup of tea, you’re not alone. Most small business owners don’t feel entirely confident when it comes to things like accounting and managing business finances. After all, you started your business to follow your heart, not to solve equations. And while these equations seem pretty straightforward on paper, they can get a bit more complicated in practice.

An automated accounting software like QuickBooks makes it easy to run financial reports and plug the numbers for these equations. Once your transactions are synced, your accounting software can crunch the numbers for you. And, of course, if you’re feeling overwhelmed by all the pluses and minuses, an accounting professional can help.

Remember, the more knowledge you have about your business’s financial health, the better you can run your business.

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