10 Basic Financial Formulas: Not Knowing 'em Will Cost You

Finance is all about numbers.

Luckily, you don’t have to be a mathematician to find your way around the figures.

Would you like to know what your net worth means and how to calculate it?

How about the difference between simple and compound interest – or what the heck the rule of 72 is and what it means for your money?

Here are 12 financial formulas you should know:

Table of Contents

1. How to Calculate Your Cash Flow

Calculating your cash flow is one of the most simple formulas and most likely one of the first ones you learned in high school.

It’s down to how much you’re bringing in and how much you’re spending – if you’re carrying a negative balance at the end of this formula, you need to re-evaluate your finances.

Income – Expenses = Cash Flow

2. How to Calculate Your Net Worth

Your personal net worth, simply, is what you own minus what you owe.

Again, you’re looking for a positive balance here.

According to the Forbes Billionaires List, Bill Gates currently tops it at the time of this writing with a net worth of $75 billion.

Remember: You might not be starting there, but neither did he.

Assets – Debts = Net worth

3. How to Calculate Simple Interest

Simple interest applies when you need to find out the interest being charged on a loan.

It’s also referred to as principal interest because the interest accrued is based only on the principal amount.

I = p x r x t

I = Interest

p = principal amount

R = rate of interest charged per year (as a decimal number)

T = How long the money is borrowed or invested for (in years)

4. How to Calculate Compound Interest

Compound interest refers to calculating the compounded interest, not just the interest gained on the principal invested or borrowed amount.

A = P (1 + r/n) nt

A = The amount earned after interest

P = The principal amount

r = The annual interest rate (as a decimal)

n = The number of times the interest is compounded (per year)

t = How long the money is borrowed or invested for (in years)

5. How to Calculate Price to Earnings Ratio

Here’s a formula that’s useful if you’re watching stocks or companies – use it to calculate the relationship between a company’s share prices and per-share earnings.

This can tell you if stocks are over- or undervalued.

Price to Earnings Ratio = Price per share / Earnings per share

For example, Microsoft Corporation on the 20th of July 2016 traded at $56, 52 per share, and the EPS was listed at $0.69 according to this piece on News is Money.

6. How to Calculate the Break-even Point

Knowing when you’re breaking even is an essential part of a successful business venture.

Use this formula to calculate when you’ll finally be breaking even – or to find out if you already have:

Break-even point (in dollars) = Fixed expenses / Gross profit margin (in percentage)

7. How to Calculate Net Income?

Here’s a simple way to figure out your business’s net income:

Net income = Revenue – Expenses

8. How to Calculate the Variation of Investment

Calculating the variation of your investment tells you what’s happened to your investment over a period of time: Has it gone up, or has it tanked?

Expressed as a decimal ratio, the result tells you how much more (or less) your purchase is worth.

Purchase price variation = (Current price – purchase price) / purchase price

9. The Rule of 72

The rule of 72 is a useful trick that tells you how many years your investment will need to double in value at a specific annual return rate.

Simply, how long will it take to double what you put into it?

The same formula can also be used to figure out how long it could take you to double your debt – steer carefully!

Years needed to double your investment = 72 / compound interest rate (per year)

10. Your Basic Liquidity Ratio

Basic liquidity ratio tells you how long (in months) a family will be able to cover their expenses with the assets they have.

This is useful for personal finance when the breadwinner is no longer able to bring in money (which can sometimes happen for a varying amount of reasons).

In the case of companies, it’s used to calculate how long a company can survive off their current assets should they need to.

Here’s how:

Basic liquidity ratio = Monetary assets (in dollars) / Monthly expenses (in dollars)

The end-result is expressed as a decimal, and according to Xplained.com, it’s advised to have a basic liquidity ratio of at least three months.