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Some Accounting Equations for Businesses to Know

 

  • The Accounting Equation

Equation: (Assets = Liability + Owner’s Equity)

What It Means:

  • Assets: You can think of accounts as the money or things that you own. They include assets like bank accounts, buildings, and money that people owe you
  • Liabilities: You can think of accounts as the money or things that and the debts that you owe. They include liabilities like credit cards or loans from banks.
  • Owner’s Equity: The owner's equity account holds the owner's original investment in the company and any retained earnings that have been moved into it at the end of each fiscal year. It shows the value or net worth of the company to its owner(s). Simply put, it's the company assets minus the company liabilities.

  • Net Income

Equation: (Revenues – Expenses = Net Income)

What It Means:

  • Revenuesare the sales or other positive cash inflow that comes into your company.
  • Expensesare the costs that are associated with making sales.
  • By subtracting your revenue from your expenses, you can calculate your net income. This is the money that you have earned at the end of the day. It’s possible that this number will be negative when your business is in its nascent stage, so the goal is for your business’ net income to become positive, meaning your business is profitable.

  • Break-Even Point

Equation: (Break-Even Volume = Fixed Costs / Sales Price – Variable Cost Per Unit)

What It Means: 

  • Fixed Costsare recurring, predictable costs that you must pay in order to conduct business. These costs include insurance premiums, rent, employee salaries, etc.
  • Sales Priceis the retail price you sell your products or services for.
  • Variable Cost Per Unitis the amount it costs you to make your product.
  • If you divide your fixed costs by the sale price of your product, minus the amount it costs to make your product, you’ll have a break-even point, which tells you how much you need to sell in order to cover all of your costs.

  • Cash Ratio

Equation: (Cash Ratio = Cash / Current Liabilities)

What It Means:

  • This gives you an idea of how much cash you currently have on hand.
  • Cashis simply the amount of cash you have at your disposal. This can include actual cash and cash equivalents (i.e. highly liquid investment securities).
  • Current Liabilitiesare the current debts the business has incurred.
  • This ratio demonstrates how well your business can pay off its current liabilities. In this case, the higher the number, the healthier your company.


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