Accounting Equations
Htay Aung (Chris)
Introduction to Accounting Equations
Accounting equations form the backbone of financial accounting, providing a framework for understanding the financial health of a business. These equations are not just critical for finance experts but also for small and medium-sized enterprise (SME) owners. By mastering these essential accounting equations, SME owners can make informed decisions, ensure accurate financial reporting, and maintain the trust of stakeholders.
The Importance of the Accounting Equation in Financial Statements
Every transaction a business undertakes has an impact on the accounting equation. For example, when an SME takes out a loan, both assets (cash) and liabilities (loan) increase. Similarly, when the business earns revenue, assets (cash or receivables) and equity increase. These changes are reflected in the financial statements, which are essential tools for evaluating business performance and planning future strategies.
For SME owners, maintaining a balanced accounting equation ensures that their financial statements are accurate and reliable. This accuracy is crucial for securing financing, attracting investors, and complying with regulatory requirements.
ACCOUNTING EQUATIONS
1. Gross Profit = Sales - Cost of Goods Sold
2. Gross Profit Margin = (Gross Profit / Sales) x 100
3. Operating Profit = Gross Profit - Operating Expenses
4. Operating Profit Margin = (Operating Profit / Sales) x 100
5. Net Profit = Operating Profit - Taxes and Interest
6. Net Profit Margin = (Net Profit / Sales) x 100
7. Return on Investment (ROI) = (Gain / Cost) x 100
8. Return on Equity (ROE) = (Net Profit / Shareholder Equity) x 100
9. Asset Turnover = Sales / Total Assets
10. Inventory Turnover = Cost of Goods Sold / Average Inventory
11. Days Sales Outstanding (DSO) = Accounts Receivable / Sales x Number of Days
12. Days Inventory Outstanding (DIO) = Inventory / Cost of Goods Sold x Number of Days
13. Current Ratio = Current Assets / Current Liabilities
14. Quick Ratio = (Current Assets - Inventory) / Current Liabilities
15. Debt-to-Equity Ratio = Total Debt / Shareholder Equity
16. Earnings Per Share (EPS) = Net Profit / Number of Shares
17. Price-Earnings Ratio (P/E Ratio) = Stock Price / EPS
18. Break-Even Point (BEP) = Fixed Costs / (Selling Price - Variable Costs)
19. Margin of Safety = (Sales - BEP) / Sales
20. Cost of Goods Sold (COGS) = Direct Materials + Direct Labor + Overheads
21. Operating Leverage = (Operating Profit / Sales) x (Sales / Fixed Costs)
22. Financial Leverage = (Net Profit / Operating Profit) x (Operating Profit / Sales)
23. Return on Assets (ROA) = Net Profit / Total Assets
24. Return on Capital Employed (ROCE) = EBIT / (Total Assets - Current Liabilities)
25. Residual Income (RI) = Net Profit - (Total Assets x Cost of Capital)
26. Economic Value Added (EVA) = Net Profit - (Total Assets x Cost of Capital)
27. Cash Conversion Cycle = DIO + DSO - Days Payable Outstanding (DPO)
28. Asset Utilization = Sales / Total Assets
29. Profitability Index (PI) = Present Value of Future Cash Flows / Initial Investment
30. Accounting Rate of Return (ARR) = Average Annual Profit / Average Investment
31. Payback Period = Initial Investment / Annual Cash Inflows
32. Discounted Payback Period = Initial Investment / Discounted Cash Inflows
33. Net Present Value (NPV) = Present Value of Future Cash Flows - Initial Investment
34. Internal Rate of Return (IRR) = Discount Rate that sets NPV to zero
35. Cost of Capital = Weighted Average of Debt and Equity Costs
36. Weighted Average Cost of Capital (WACC) = (Cost of Debt x Debt) + (Cost of Equity x Equity)
37. EBITDA = Net Profit + Interest + Taxes + Depreciation + Amortization (EBITDA = Earnings Before Interest, Taxes, Depreciation, and Amortization)
38. Interest Coverage Ratio = EBIT / Interest Expenses
39. Times Interest Earned (TIE) = EBIT / Interest Expenses
40. Cash Flow Margin = (Operating Cash Flow / Sales) x 100
41. Cash Flow Return on Investment (CFROI) = Operating Cash Flow / Total Assets
42. Free Cash Flow (FCF) = Operating Cash Flow - Capital Expenditures