Even if you plan to hire someone to do your bookkeeping for you, it’s important to have a general understanding of the different formulas and terms used in bookkeeping and financial accounting.
Assets = Liabilities + Owner’s Equity
- Assets – What you own for your business, which includes all furnishings, inventory, property and so forth.
- Liabilities – Anything that you need to pay to stay in business: loans, taxes, fees, and so forth.
- Owner’s Equity – This is what you’ve invested in the business minus the draws you’ve taken on the business, plus the net income of the business since the day your business began.
Net Income = Revenues – Expenses
- Revenues – The cash flow you get from sales.
- Expenses – The costs associated with the sale.
- Net Income – The money left from revenue after all your expenses are deducted.
Break-Even Point = Fixed Costs / Sales Price – Variable Costs Per Unit
Fixed Costs – Many fixed costs are costs that recur such as rent, software subscriptions, salaries, insurance and so forth. If you need to have it in order to produce the product and make the sale, then it’s a fixed cost.
Sales Price – The price you actually sell the item at.
Variable Costs per Unit – This is how much it cost to make each item that you sell. If you are selling digital products, the VCPU is zero. If you make a physical product, the cost typically goes down the more items you produce.
Break-Even Point – This is how much you need to make to stay in business to simply cover your business costs or cost of doing business.
Profit Margin = Net Income / Sales
Net Income – The amount of money you’ve earned after all your expenses have been deducted from revenue.
Sales – How many sales you’ve generated in the period.
Profit Margin – You want to look at this number to ensure that your net income is reasonable for your industry. If you have a low profit margin, your company may need some tweaks to fix it. If you have a high profit margin, then you’re doing great. You can check this with industry standards to see where you stand.
Cost of Goods Sold = Cost of Materials / Inventory – Cost of Outputs
This formula is only needed if you actually produce something yourself. For example, if you make knit items for sale on Etsy, then you’ll need this to ensure that your business is healthy and your costs aren’t too high for what you’re charging people.
Cost of Materials / Inventory – How much does it cost your business to buy the materials, tools and more, necessary to produce your product? You can figure this out by working out how much you spent on materials, then dividing it by the cost of the inventory’s worth.
Cost of Outputs – How much did it cost you in total to produce the items you plan to sell?
Cost of Goods Sold – This is what you’re paying to make your product. It’s a good figure to know so that you know how you fit in with the rest of your industry. Plus, if you don’t know this figure, how can you know if you’re really profitable as you could be?
*This article is not intended to replace professional business advice and planning. Always contact professionals regarding any business advice, financials, planning, operations, and/or management.