Accounting involves tracking and keeping a record of financial transactions of an organisation. Multiple functions build accounting into what it is, which are classifying, summarising, verifying, interpreting, recording, etc. data related to finances of that particular institution.
From the viewpoint of an organisation, 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 at the right conclusion from an interpretation requires the proper use of 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.
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.
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.
The expenditure that is related to conducting production and sales activities is categorised under expenses.
Regular expenses that are incurred in a business to keep it functioning despite the productivity level, such as building rent and warehouse maintenance.
Costs or expenses that differ based on the sales volume or productivity of business are variable.
It is the retail price at which a company or business sells its products or services to the public.
Assets that are likely to be converted into cash or probably consumed or exhausted within a financial year is termed as a current asset.
The debts or liabilities that a company is expected to make good within a year are classified as current liabilities.
Total equity refers to the owned capital of an organisation held by the shareholders or private owners. It is the difference between the total assets and total liabilities of a company.
Inventory refers to the value of goods (raw materials, semi-finished and finished products) held by an organisation.
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.
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 debit balance.
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 a 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 its 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 in the right path towards effective exam preparation. So, get your notes now and jumpstart your exam preparation.
1.What is the Basic Accounting Equation?
Ans: The basic accounting equation is that assets are a combination of equities and liabilities together. Herein, assets include property, cash, equipment, etc. Liabilities are the expenses to be paid by the business such as lease payments, debts, etc. Equity is the owner's share in a business.
2.What is Accounting?
Ans: The act of keeping a record of financial transactions in a business or company is called accounting. An accountant has to indulge in activities such as collecting, interpreting, classifying and summarising the financial data collected and represented in reports for future assessment.
3.What is the Significance of Accounting?
Ans: Accounting in a firm or business allows in comprehending the financial position of a company or business. It helps in analysing the past performances in sales and marketing and also looks into areas that can be further improved to garner more sales and thereby, increase the profit margin.