Easy to understand finance formulas for SMEs

Finance Formula for SME

Accountancy and finance have a long glossary of closely associated terms and formulas. For non-financial professionals, this level of jargon may prove to be overwhelming or anxiety-inducing. Knowledge is power, and as a business owner, having background knowledge of basic financial terms and processes is imperative.

Whether you handle bookkeeping or outsource it, a grasp of financial terminology will empower you to have better conversations with your financial professionals and make smarter decisions for your business.

EasyBiz Technologies provides this layman’s guide to finance and accounting to help small and medium-sized enterprises (SMEs) understand some of the must-know financial terminology.

Understanding Financial Reports

Income statements, balance sheets, and cash flow statements are among the most commonly used financial statements. Each provides a different view of your business’s financial performance and progress. This is the information you will need to make informed decisions and identify potentially problematic areas.

Balance sheets show your assets, liabilities, and owner’s equity. That includes your inventory valuation, which needs to follow International Financial Reporting Standards (IFRS).

Bank statements are important financial statements even though they are often overlooked. 

Performing weekly bank reconciliations lets you spot errors faster, so you can make corrections before they become a huge issue.

Using online accounting services for small businesses can help you keep track of data needed for financial statements. Cloud-based online accounting offers a secure way to store information that’s easily accessible from any mobile device. And with QuickBooks, you can handle many day-to-day tasks, such as creating receipts and invoicing clients.

Must-Know Formulas

Effective accounting is a potent business tool with a wide range of capabilities. It can help you set goals and assess your profitability. Knowledge of the following common accounting formulas and how to use them is beneficial to SME owners.

Accounting Equation

Also called the balance sheet equation, the accounting equation adds together liabilities and owner’s equity, and the result should be equal to the company’s assets. As explained above, this equation is showcased on your balance sheet, and it looks like this:

Liability + Owner’s Equity = Assets

You can also rewrite this equation as assets minus liability equals owner’s equity. Note that liabilities refer to all the debts your company owes, and this includes operating expenses such as payroll, leases and utilities. Assets are everything your company owns, and owner’s equity, of course, is the amount of equity the owners and shareholders have in the company.

Current Ratio

The current ratio helps you compare your current assets to your liabilities. To find this ratio, just divide your current assets by your current liabilities.

Current Assets / Current Liabilities = Current Ratio

For instance, if your current assets are worth R100,000 and your current liabilities are R50,000, your ratio is 2. Lenders look at the current ratio when offering funding, and generally, they want to see approximately 1.2 or higher, but that can vary depending on your industry. If your ratio is less than 1, that indicates you don’t have enough assets to cover your liabilities.

Variable Cost Ratio

Used by retailers or anyone else who sells goods, the variable cost ratio compares your total variable expenses to your net sales.

Variable Costs / Net Sales = Variable Cost Ratio

For instance, if you incur R60,000 in variable costs and you have R100,000 in product sales, your variable cost ratio is 60%.

Gross Profit

Gross Profit = Revenue – Cost of Goods Sold (COGS)

Keep in mind that COGS only takes into account the direct costs you incur producing goods, such as labour, materials, equipment used in production and utilities for your manufacturing facility. It does not take into account other fixed costs or taxes.

Ending Inventory

Ending inventory refers to the value of the goods you have on hand at the end of a reporting period. This number can include your raw materials, raw materials in the midst of manufacturing and finished goods. You can assess your ending inventory just by adding up all the value of these items, but you can also use this equation:

COGS – Beginning Inventory – Purchases = Ending Inventory

By moving around some of these values, you can also use ending inventory to calculate your COGS. To do this, you take your beginning inventory. Then, you add in your purchases and subtract your ending inventory. Now you know your COGS.

Budgeting

Calculating how much to pay yourself, deciding whether to earn a salary or dividends and determining your business’s minimum monthly profit should be informed by a master budget, which is why every business needs one.

Sometimes, even the best budgets go astray. Learning how to use variance analysis supports a comparison of your budgeted vs. actual performance.

Money Management

Effectively managing your business’s working capital is central to financial control and management. A SMEs operational efficiency and overall success are largely dependent on this aspect. Managing debtors, paying vendors on time, and considering currency exchange rates when operating internationally are just some of the few important decisions involved with managing working capital.

Effective money management will also help determine the right balance of liquidity for your business. Liquidity mismanagement can have drastic consequences for a business, ranging from being unable to keep up with bills, to struggling to get approved for financing or handle emergencies. 

The quick ratio is one way to calculate your short-term liquidity. By looking at your liquidity, you may find that you’re holding onto too much cash, or that you may need more liquid assets to cover short-term liabilities.

Should You Hire an Accountant

As a non-financial professional SME owner, there are multiple reasons to consider why outsourcing your business’s bookkeeping is advisable. Small business accounting differs from big business accounting, so specifically hiring a small business accountant is imperative.

Often, the earlier an SME owner realises that they cannot do it all within their business and choose to hire professional help, the better. This preventative action can save you from mountains of stress, and simultaneously improve your business. Whether you decide a bookkeeper or accountant is best suited for your business’s demands, join the over 5.6 million customers who use QuickBooks, the essential accounting software for SMEs. 

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Please fill out the form below to receive the trail demo link

Personal Information
Where a party receives any personal information (“PI”) related to the other party, the party who receives the PI, will comply with and have adequate measures in place to ensure that its employees, agents, subsidiaries and representatives comply with the provisions and obligations contained in the Protection of Personal Information Act, No. 4 of 2013. Any PI pertaining to one party which is required by the other party, will only be used by that other party for the purposes of this contract and will not be further processed or disclosed without the written consent of the latter and the recipient of that PI will take all reasonable precautions to preserve the integrity and prevent any corruption or loss, damage or destruction of the PI. If and when the contract is terminated, each party will, save to the extent that it is required to do otherwise by any applicable law, erase or cause to be erased, all PI and all copies of any part of the PI relating to the other party”.