Accounting Formulas
10 essential formulas and financial ratios with detailed explanations, examples, and when to use them.
The Accounting Equation
Assets = Liabilities + Shareholders' Equity
The fundamental equation underlying all of accounting. Every transaction must keep this equation in balance. This equation shows how a company's resources (assets) are financed - either through debt (liabilities) or owner investment and retained earnings (equity).
Current Ratio
Current Ratio = Current Assets / Current Liabilities
The current ratio measures a company's ability to pay short-term obligations with short-term assets. It's one of the most commonly used liquidity ratios by creditors and investors to assess short-term financial health.
Quick Ratio (Acid-Test)
Quick Ratio = (Current Assets - Inventory) / Current Liabilities
The quick ratio is a more stringent liquidity measure than the current ratio. It excludes inventory because inventory may not be quickly convertible to cash. Also known as the acid-test ratio, it shows ability to meet short-term obligations with the most liquid assets.
Debt-to-Equity Ratio
Debt-to-Equity Ratio = Total Liabilities / Shareholders' Equity
The debt-to-equity ratio measures a company's financial leverage by comparing total debt to shareholders' equity. It indicates how much debt a company uses to finance its assets relative to the value of shareholders' equity.
Gross Profit Margin
Gross Profit Margin = (Revenue - Cost of Goods Sold) / Revenue × 100
Gross profit margin measures the percentage of revenue that exceeds the cost of goods sold. It shows how efficiently a company uses labor and materials to produce goods or services, and how much is available to cover operating expenses and generate profit.
Net Profit Margin
Net Profit Margin = Net Income / Revenue × 100
Net profit margin represents the percentage of revenue that remains as profit after all expenses are deducted, including operating expenses, interest, and taxes. It's the "bottom line" profitability measure.
Return on Equity (ROE)
ROE = Net Income / Shareholders' Equity × 100
Return on equity measures how effectively a company generates profits from shareholders' investments. It shows the return generated on money invested by shareholders and is a key metric for comparing management effectiveness.
Return on Assets (ROA)
ROA = Net Income / Total Assets × 100
Return on assets measures how efficiently a company uses its assets to generate profit. Unlike ROE, ROA is not affected by capital structure, making it useful for comparing companies with different leverage levels.
Inventory Turnover
Inventory Turnover = Cost of Goods Sold / Average Inventory
Inventory turnover measures how many times a company sells and replaces its inventory during a period. Higher turnover indicates efficient inventory management and strong sales, while low turnover may indicate overstocking or weak demand.
Earnings Per Share (EPS)
EPS = (Net Income - Preferred Dividends) / Weighted Average Common Shares Outstanding
Earnings per share represents the portion of a company's profit allocated to each outstanding share of common stock. It's one of the most widely used metrics for valuing stocks and comparing profitability.
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