Accounting involves tracking and keeping a record of the financial transactions of an organization. Multiple functions build accounting into what it is, which are classifying, summarising, verifying, interpreting, recording, etc. data related to the finances of that particular institution.
From the viewpoint of an organization, it should be noted that accounting also deals with profits and losses incurred due to the trading of goods and services. Additionally, it also keeps records of assets and liabilities for a company.
Naturally, the data relating to accounting is represented in numbers, and deriving the right conclusion from an interpretation requires the proper use of the accounting formula. You should note that these formulas are the foundations of accounting. To build a stronghold on accounting and indulge in higher studies relating to accounts, you need to grasp the methods right from their grassroots.
Here is a detailed analysis of accounting and its formulas that are important in studying accounting.
What is an Accounting Formula?
To assess the functioning of a small business or even a large one, there is a set of specific accounting equation formulas that is most handy. They can be used as first-hand solutions to derive a conclusion depending on the business needs.
The formulas are listed below for your convenience.
-
Current Ratio = Current Assets/ Current Liabilities
-
Net Income = Income – Expenses
-
Cost of Goods Sold = Opening inventory value + Purchases of inventory – Closing inventory value
-
Gross Profit = Sales – Cost of Goods Sold
-
Gross profit Margin = Gross Profit/ Sales
-
Break-Even Point = Fixed costs / (Sales per unit cost – Fixed cost per unit)
-
Inventory Turnover Ratio = Costs of Goods Sold/ Inventory
-
Accounts Receivable Turnover Ratio = Sales on Credit/ Accounts Receivable
-
Quick Ratio = (Current Assets – Inventory)/ Current Liabilities
-
Return on Assets = Net Income/ Average Total Assets
-
Return on Equity = Net Income/ Average Shareholder’s Equity
Merely learning these formulas is less likely to be effective in dealing with numerical that are included under this topic. Therefore, a student has to build the basics of all these terminologies to tackle numerical and advanced concepts.
Understanding the Concepts
Let us understand some essential terms included in the accounting formula that is given below.
Income or Revenue
The cash inflows to a company or business are considered under revenue.
Expenses
The expenditure that is related to conducting production and sales activities is categorised under expenses.
Fixed Costs
Regular expenses that are incurred in a business to keep it functioning despite the productivity level, such as building rent and warehouse maintenance.
Variable Cost
Costs or expenses that differ based on the sales volume or productivity of business are variable.
Sales Price
It is the retail price at which a company or business sells its products or services to the public.
Current Assets
Assets that are likely to be converted into cash or probably consumed or exhausted within a financial year are termed as current assets.
Current Liabilities
The debts or liabilities that a company is expected to make good within a year are classified as current liabilities.
Total Equity
Total equity refers to the owned capital of an organization held by the shareholders or private owners. It is the difference between the total assets and total liabilities of a company.
Inventory
Inventory refers to the value of goods (raw materials, semi-finished and finished products) held by an organization.
Hence, it is crucial to understand all these terms before delving deeper into the topics of accounting. You must have a holistic understanding of all these to strengthen your foundation so that you can navigate through the advanced topics more conveniently.
What is the Basic Accounting Equation?
The basic accounting equation is Assets = Equity + Liability.
It is also known as the balance sheet equation. The double-entry bookkeeping system is founded on this very equation, as it represents that the total credit balance equates to a total debt balance.
What is the Comprehensive Accounting Equation?
A comprehensive formula for the basic accounting equation is its expanded form. Commerce students have to note that multiple different factors are included in a firm, proprietorship, or company.
Hence, while calculations are carried out, there might be a slight change in the parameters that are considered. For instance,
In the case of a corporation, Assets = Liabilities + Paid-in Capital + Revenues – Expenses – Dividends – Treasury Stock
Similarly, in the case of a sole proprietorship is: Assets = Liabilities + Owner’s Capital + Revenues – Expenses – Owner’s Draws
Hence, it is evident that certain parameters differ based on the entity for which the valuation of assets is being done.
To know more about accounting activities and their formulas in calculating those, look into our online learning programmes for a clear understanding. We provide high-quality study materials prepared by subject professionals to guide you on the right path towards effective exam preparation. So, get your notes now and jumpstart your exam preparation.