# Financial Formulas Basics: Simple Explanation and Formulas

## Why Do You Need to Understand Financial Formulas?

Whether you are looking at your own personal finances or at a business it is very important that you know how to check the performance of your money using some of the common financial formulas. You want to be able to see that you are getting a good return on your investments and that you are not spending out more than you can afford. But if you don’t understand how those calculations are made it can be hard to know where you really stand. That’s why here is a helpful finance formula sheet.

Whether you need to understand finance math formulas for your finance assignments or for your own personal needs we can help you. The following sections will run through some of the most common formulas that you will need to understand and provide you with simple and easy to follow explanations and examples.

## Formula for Operating Cash Flow

Understanding your cash flow is very important if you don’t want to end up in serious problems. The ideal is always to have an income that is greater than your expenses so that you will always be earning more than you are spending. A negative value for your cash flow indicates that you are simply spending more than you are earning, something that you really want to avoid. A positive cash flow provides you with a surplus that you can then save or even better invest to generate additional income. The formula for operating cash flow is not a difficult one to remember or to understand and is:

The formula for operating cash flow is not a difficult one to remember or to understand and is: Cash Flow = Income – Expenses

So if you have an income of \$2500 per month and your expenses total \$2250 each month then your cash flow is: \$2500 – \$2250 = \$250

Cash flow should always be calculated over a long period to get a better and more accurate measure. This is so that you take into account expenses that may be annual such as insurance and allow for any seasonal or other variations in your income.

## What Is Leverage Ratio?

Leverage is your use of borrowed capital, or the debt that you have. Most people and businesses also operate with some form of debt, whether that is your mortgage, a car loan, or an overdraft. The important thing is to not have too great a level of debt when compared to your income.

The formula for your leverage ratio is: Leverage Ratio = Debt Payments ÷ Income

So if your income is \$3000 per month and you make payments of \$750 on your debts during the same period then your leverage ratio is: \$750 ÷ \$3000 = 0.25 or 25%

As a rule of thumb it is best to maintain your leverage ratio at less than 33% of your regular income. The lower the ratio then the safer you are if you should take some form of financial hit such as redundancy.

## Leverage Ratio Using Equity

Your leverage can also be calculated against the equity that you hold. For instance if you own a house or business property that is worth \$500,000 and your mortgage on the property is \$200,000 then you have an equity of \$300,000.

The formula for your leverage ratio compared to equity is: Leverage ratio = Total debt ÷ Total equity

So for the figures quoted above our equity leverage ratio is: \$200,000 ÷ \$300,000 = 0.67 or 67%

The lower that you keep this ratio the more secure you are. This is often used as a measure of risk that you currently have and should be considered before making additional investments or other changes.

When you make any form of investment you will want to know how that investment is going to perform when compared to the current or expected rate of inflation. Money that is simply kept under the mattress is going to lose real purchasing power when you take into account inflation. So in real terms after about 20 years if inflation is running at around 3% your stash of cash under your bed will only be able to buy half of what it could today

The calculation for inflation adjusted return is simply: [(1 + Investment return) ÷ (1 + Inflation rate) – 1] x 100

So for money invested at 8% when inflation is running at 3% the calculation will be: [(1.08 ÷ 1.03) – 1] x 100 = 4.85%

Which means your money will see a real growth of 4.85% not 8% when compared against how inflation is performing.

## Calculating Your Market Gains or Losses

If you buy something as an investment such as stocks or property you will want it to appreciate in value to increase the equity that you hold.

Knowing how to calculate the gains or even losses that you have made is done through the following calculation: Percentage Increase = (Market Price – Purchase price) ÷ Purchase price

So if you bought stocks at \$6 and they are now worth \$10 your gains would be: (\$10 – \$6) ÷ \$6 = 67% gain

A negative figure here would indicate the percentage loss that you have made on your investment, this of course is something that you will want to avoid.

## Making Calculations Using MS Excel

One of the most common assignments that you may be set is to set up a simple spreadsheet to undertake these calculations, or you may wish to just use them for yourself within your business or for your personal finances. Excel and other similar packages offer an easy way for doing all of these calculations. For the financial formulas list discussed above the following are how you should write the formulas and organize your spread sheets:

• Cash flow in Excel
 A B 1 Cash Flow Calculation 2 Income \$2,500 3 Expenses \$2,250 4 Calculation =B2-B3 (Answer) \$250
• Debt leverage ratio
 A B 1 Leverage Ratio (Debt) 2 Income \$3000 3 Debt \$750 4 Calculation =B3/B2 (Answer) 25%
• Equity leverage ratio
 A B 1 Leverage Ratio (Equity) 2 Equity \$300,000 3 Debt \$200,000 4 Calculation =B3/B2 (Answer) 67%
 A B 1 Inflation Adjusted Return 2 Investment Return 8% 3 Inflation Rate 3% 4 Calculation =((1+B2)/(1+B3))*100 (Answer) 4.85%
• Gains or losses
 A B 1 Gains or Losses 2 Market Price \$10 3 Purchase Price \$6 4 Calculation =(B2-B3)/B3 (Answer) 67%

Similar spreadsheet programs that are available online through Google and Open Office to name just two will use a similar formula to that used above to do the mathematical calculations. Always test your formulas to make sure that they do return the answers that you expect. Don’t just submit assignments with untested formulas that may or may not work as they need to.

## Using Online Tools for Your Financial Calculations

The good thing about established and recognized calculations is that there are many websites that will provide you with simple calculators and other tools to solve the equation that you have been set. As with anything online however you should never just simply accept that they are going to give you the right answer. You must always check that they use the correct financial formulas before you just blindly accept their results.

The following are 5 websites that offer online calculation tools that you can use freely to get answers to your many calculations:

• Financial Calculator – This offers a wide variety of different tools that you may need
• The Calculator – All of the different formulas and calculators that you will want
• Money – Zine – A full range of different calculators for all purposes
• Financial Analysis Hub – This website provides a range of different calculators for you to use
• Calkoo – A wide range of easy to use financial calculators

The sites above offer tools and calculators that could be used for both personal use, businesses and for your assignments at school and college.

Image credit: krntu.com

## Getting Help with Your Financial Calculations

There are many more commonly used formulas that you will need to fully understand for your assignments in addition to the financial formulas list above. Keeping them all straight in your head and knowing when to apply them and why can be a very difficult task. This is why you may want to use our professional and very effective finance homework help.

We can provide you with support that is carefully tailored to your specific needs through post graduate qualified finance professionals that will fully understand what is required for your assignment. They will be able to help you to fully understand which formulas to use and how. All of the calculations that they provide for you will come with full detailed workings ensuring that you will be able to replicate what has been done.