Accounting Formulas

Accounting formulas and ratios are used to manipulate information so that accountants and other users of financial information can extract useful information to determine the health of a business.

The most basic of formulas is:
Assets = Liabilities + Owners Equity
Using algebra, we can make the following equations:
Liabilities = Assets - Owners Equity
Owners equity = Assets - Liabilities


Ratios are used for quick analysis of financial reports. There are three main categories that ratios cover:

Liquidity

Profitability

Debt Management

Liquidity ratios try to determine if a company has enough cash to pay bills and remain solvent:
The current ratio is:

Current assets / current liabilities
The rule of thumb is around a 2 to 1 ratio

The quick ratio is:

(cash + marketable securities + receivables) / current liabilities
The rule of thumb is a ratio of 1 to 1

The receivable turnover is:

Sales / average accounts receivable
Each industry has their own rule of thumb

Inventory turnover:

Cost of goods sold / average inventory
Each industry has their own rule of thumb

Profitability ratios try to determine if the business is earning enough to stay in business, or if the money invested could earn more elsewhere:
Profit margin on sales ratio:

Net income / sales
Rule of thumb is 2% to 5%

Asset turnover:

Sales / average total assets
Measures sales produced compared to asset investment

Return on equity:

Net income / average owners equity
Ratio is the percent return on equity invested

Debt management ratios:
Debt to equity ratio:

Total liabilities / owners equity
Rule of thumb is 1 to 1

Total debt to assets:

Total debt / total assets
Lenders like to see low debt ratios
To have a high debt ratio means the company is leveraged