No matter the type of business or industry, being able to analyze and deduce patterns is essential to discovering a business’ financial health. Here are four commonly used calculations to help internal and external stakeholders determine an organization’s ability to manage its finances.
Break-Even Analysis
This formula analyzes fixed costs versus the profitability a business earns for every extra item it creates and sells.
Businesses that have smaller thresholds to meet their fixed costs to realize profitability have an easier break-even point to meet and exceed. Once the fixed costs threshold is satisfied and sales revenue outpaces variable costs, a business will know when it hits the break-even point.
Break Even Point (BEP) = Total Fixed Costs/(Price Per Unit – Variable Cost Per Unit)
This takes the total fixed costs divided by the price per individual unit minus each unit’s variable cost.
Examples of fixed costs are rent, taxes, insurance and wages. Examples of variable costs are raw materials, production supplies, utilities and packaging.
Another way to determine a company’s break-even point is as follows:
Contribution Margin = Item Price – Variable Cost Per Unit
This is illustrated by: $55 = ($85 – $30)
The item’s priced at $85, with a variable cost of $30, the contribution margin is $55 of how much revenue a company earns to pay for the remaining fixed costs.
Cash Ratio Formula
The cash ratio formula offers one way to look at a company’s liquidity position by comparing a company’s cash and cash equivalents to its current liabilities or debts due within the next 12 months. It shows how well positioned a business is (or is not) able to pay debts due within 12 months, and to satisfy the near-term obligations of its long-term debt.
It’s an important ratio that lenders look at when evaluating a company’s loan application. Instead of including assets such as accounts receivables, it factors in a business’ ability to take care of its financial obligations. It’s thought of as being a more real world look at how financially stable a business is.
It’s calculated as follows: Cash Ratio: Cash + Cash Equivalents/Current Liabilities.
Gross Profit Margin
This is defined as all income minus the cost of goods sold (COGS). COGS is comprised of expenses attributable to the creation of products, which include input materials and salaries for workers to produce such goods. However, it excludes expenses for taxes, overhead, debt, asset acquisitions, etc., among others. Another way to explain this calculation is to ask how much a business retains as profit once production costs are accounted for.
It’s calculated as follows: Gross Profit Margin = [(Net Sales – Cost of Goods Sold)/(New Sales)] x 100
Debt-to-Equity (D/E) Ratio
This is used to determine how much debt or financial leverage a company has on its books. It tells internal stakeholders and external parties what percentage of debt a company is using to operate compared to the business’ available operating reserves. This ratio contrasts a business’ complete financial obligations against its shareholder equity. Its primary use is to see how extensively it uses debt to operate.
It’s calculated as follows: Debt/Equity Ratio = Total Liabilities/Total Shareholders’ Equity.
While these calculations may seem straightforward, these are only a few examples of how businesses can calculate and analyze a company’s position – be it the owner, an employee or an outside lender or investor.
Disclaimer 
Comments are closed, but trackbacks and pingbacks are open.