4 Min. Read

6 Finance Equations You Should Know

August 3, 2021

Finance is all about numbers.

And when you’re talking about numbers, you won’t be too far away from talking about equations.

Mixing numbers and letters and trying to figure out who and what a “Pythagoras” is can be a daunting task.

So we’ve compiled a list of the best 6 finance equations you should know to help you smooth and streamline your finance department.

Here’s What We’ll Cover:

1. Accounting Equation

2. Cash Flow Equation

3. Break-Even Equation

4. Simple Interest Equation

5. Compound Interest Equation

6. Profit Margin Equation

Key Takeaways

1. Accounting Equation

The accounting equation, otherwise known as the balance sheet equation, is one of the most important formulas out there.

The Formula

Total Assets = Liabilities + Equity

The Breakdown

Assets: Your assets are everything your company owns. This includes property, cash, inventory and any equipment.

Liabilities: These are any obligations that you must pay. It may include lease payments, debt or account fees.

Equity: Your equity is the portion of the company that belongs to you. If shareholders own the majority of the company, then the stockholders’ equity falls into this category.

2. Cash Flow Equation

Calculating your cash flow is an important part of running your business. Luckily it’s a very simple formula.

The Formula

Income – Expenses = Cash Flow

The Breakdown

Income: Your income is any money that’s coming into the business. This could be through sales, investments or gifts.

Expenses: Your expenses are any money that is leaving the business. This could include rent, buying raw materials or wages.

Cash Flow: Cash Flow is defined as what’s left after you’ve included income and expenses. If you have a positive cash flow then you are running a profitable business, if it is negative then you are losing money.

3. Break-Even Equation

When starting a business, the first goal you would want to achieve is to break even. This means that you are neither making a profit nor a loss.

The Formula

Break-even point = (Sales – Fixed Costs – Variable Cost = $0 profit)

The Breakdown

Sales: The total amount of money made from units sold.

Fixed Costs: The recurring costs of your business. These can include rent, wages and insurance.

Variable Costs: These are any costs that aren’t fixed. This can include the price of raw materials, shipping expenses and advertising costs.

4. Simple Interest Equation

Simple interest, otherwise known as principal interest, applies when you are looking to find out the interest being charged on a business loan.

The Formula

Interest = Principal Amount x Rate x Time

The Breakdown

Interest: This is the interest rate of the loan.

Principal Amount: The amount you have loaned.

Rate: The rate of interest charged per year as a decimal number.

Time: The number of years the money is borrowed or invested.

5. Compound Interest Equation

Your compound interest is the addition of interest to the principal sum of a loan. Basically, it is your interest. This one is slightly more complicated.

The Formula

A = P (1 + r/n) nt

The Breakdown

A: This is the amount earned after your interest.

P: The principal amount of the loan.

r: The annual rate of interest as a decimal.

n: The number of times per year that the interest is compounded.

t: How many years the money is borrowed for.

6. Profit Margin Equation

Knowing your profit margins is key. Too high and your product most likely won’t be good value, too low and you won’t be profitable.

The Formula

Profit Margin = Net Income ÷ Sales

The Breakdown

Profit Margin: This shows how much money you make above the costs.

Net Income: The total amount of money your business has made once you’ve removed its expenses.

Sales: The money you generate from any business activities.

Key Takeaways

Businesses are run on numbers.

That’s why a good accounting department with good accounting software is worth its weight in gold.

By making sure your accounting and finance department has all the tools it needs to succeed, you’re putting your business on the best road to success.

Are you looking for more business advice on everything from starting a new business to new business practices?

Then check out the FreshBooks Resource Hub.