Accounting Equations Cheat Sheet: Every Formula You Need
The Fundamental Accounting Equation
This equation must always balance. If a company borrows $1 million (liability increases), its cash (asset) also increases by $1 million. If it buys equipment for cash, one asset goes up and another goes down — total assets stay the same. Every journal entry is a debit-credit pair that keeps this equation intact.
Expanded Accounting Equation
Shareholders’ equity breaks down into several components, which gives you a more detailed view of what drives the right side of the equation.
Balance Sheet Equations
| Equation | Formula | What It Tells You |
|---|---|---|
| Fundamental Equation | Assets = Liabilities + Equity | Everything the company owns is funded by debt or equity |
| Working Capital | Current Assets − Current Liabilities | Short-term liquidity buffer |
| Book Value | Total Assets − Total Liabilities | Net worth on the balance sheet (= total equity) |
| Book Value Per Share | Total Equity ÷ Shares Outstanding | Equity per common share |
| Net Debt | Total Debt − Cash & Equivalents | Debt burden after netting out available cash |
| Enterprise Value | Market Cap + Net Debt + Preferred + Minority Interest | Total value of the firm to all capital providers |
Income Statement Equations
| Equation | Formula |
|---|---|
| Gross Profit | Revenue − COGS |
| Operating Income (EBIT) | Gross Profit − Operating Expenses |
| EBITDA | EBIT + Depreciation + Amortization |
| Pre-Tax Income (EBT) | EBIT − Net Interest Expense ± Other Income |
| Net Income | EBT − Income Tax Expense |
| Basic EPS | (Net Income − Preferred Dividends) ÷ Weighted Avg Shares |
| Gross Margin | Gross Profit ÷ Revenue |
| Operating Margin | Operating Income ÷ Revenue |
| Net Margin | Net Income ÷ Revenue |
Cash Flow Equations
| Equation | Formula |
|---|---|
| CFO (Indirect Method) | Net Income + Non-Cash Charges ± Working Capital Changes |
| Free Cash Flow (FCFF) | CFO − CapEx |
| FCFF (from EBIT) | EBIT × (1 − Tax Rate) + D&A − CapEx − ΔWorking Capital |
| FCFE (Free Cash Flow to Equity) | FCFF − Interest × (1 − Tax Rate) + Net Borrowing |
| Cash Reconciliation | Beginning Cash + CFO + CFI + CFF = Ending Cash |
Key Ratio Equations
These ratios are derived from the three financial statements and are the building blocks of financial analysis. For a full reference, see the financial ratios cheat sheet.
| Category | Ratio | Formula |
|---|---|---|
| Liquidity | Current Ratio | Current Assets ÷ Current Liabilities |
| Liquidity | Quick Ratio | (Current Assets − Inventory) ÷ Current Liabilities |
| Leverage | Debt-to-Equity | Total Debt ÷ Total Equity |
| Leverage | Interest Coverage | EBIT ÷ Interest Expense |
| Profitability | ROE | Net Income ÷ Shareholders’ Equity |
| Profitability | ROA | Net Income ÷ Total Assets |
| Profitability | ROIC | NOPAT ÷ Invested Capital |
| Valuation | P/E Ratio | Share Price ÷ EPS |
| Valuation | EV/EBITDA | Enterprise Value ÷ EBITDA |
The DuPont Decomposition
DuPont analysis breaks ROE into three drivers, revealing whether high returns come from margins, asset efficiency, or leverage.
Key Takeaways
- The fundamental equation (Assets = Liabilities + Equity) underpins every transaction and financial statement.
- Retained earnings is the bridge between the income statement and balance sheet.
- Free cash flow can be calculated from CFO (simpler) or from EBIT (more detail for modeling).
- DuPont analysis decomposes ROE into profitability, efficiency, and leverage — essential for diagnosing what drives returns.
- Most financial ratios are just rearrangements of balance sheet, income statement, and cash flow line items.
Frequently Asked Questions
Why must the accounting equation always balance?
Double-entry bookkeeping requires every transaction to have equal debits and credits. If a company receives $100 in cash (asset up), it must either record a liability (loan), equity (share issuance), or reduce another asset. The equation is a built-in error check — if it does not balance, something was recorded incorrectly.
What is the difference between FCFF and FCFE?
FCFF (Free Cash Flow to the Firm) is cash available to all capital providers — both debt and equity holders. FCFE (Free Cash Flow to Equity) subtracts interest payments and net debt changes, leaving only the cash available to equity holders. FCFF is used with WACC; FCFE is discounted at the cost of equity.
How does the DuPont formula help in analysis?
DuPont separates ROE into margin (profitability), turnover (efficiency), and the equity multiplier (leverage). Two companies might have identical ROE but get there differently — one through high margins, the other through high leverage. DuPont tells you which driver is responsible, which is critical for assessing risk.
What is NOPAT and why is it used?
NOPAT stands for Net Operating Profit After Tax. It measures the profit generated by core operations assuming no debt (since it excludes interest). The formula is EBIT × (1 − Tax Rate). It is the numerator in ROIC and a key input in DCF models when calculating unlevered free cash flow.
How do I calculate enterprise value from the balance sheet?
Enterprise value = Market Capitalization + Total Debt − Cash + Preferred Stock + Minority Interest. Market cap comes from the market (share price × shares), not the balance sheet. Debt, cash, preferred stock, and minority interest are all pulled from the balance sheet. EV represents the total price to acquire the business and take on all its obligations.