A handful of formulas show up in nearly every business decision: pricing, growth, financing, and profitability. Memorizing them is less important than knowing when to use which, but having a clean reference of the working math saves time and prevents the silent errors that creep into spreadsheets.
Key Takeaways
- Gross margin, net margin, and markup describe profitability from different angles.
- ROI and annualized ROI measure return; break-even measures the volume needed to cover costs.
- Compound interest and present value govern long-term decisions.
- Working capital and current ratio describe short-term liquidity.
- CAC, LTV, and payback measure customer economics in subscription and recurring-revenue models.
Profitability Formulas
Gross Margin
Gross Margin (%) = (Revenue − COGS) / Revenue × 100
Measures how much of each revenue dollar remains after the direct cost of producing the goods or services. Higher is better; industry-dependent.
Net Margin
Net Margin (%) = Net Profit / Revenue × 100
The final bottom-line measure of profitability after all costs, interest, and taxes.
Markup
Markup (%) = (Selling Price − Cost) / Cost × 100
Profit relative to cost, not to selling price. Common in retail and manufacturing. See Margin vs Markup for the conversion math.
Contribution Margin
Contribution Margin = Selling Price − Variable Cost per unit
The amount each sale contributes to covering fixed costs. The foundation of break-even analysis.
Break-Even and Cost Coverage
Break-Even (Units)
Break-Even Units = Fixed Costs / Contribution Margin per unit
How many units you need to sell to cover all fixed costs. Below this, you lose money; above this, you make money.
Break-Even (Revenue)
Break-Even Revenue = Fixed Costs / Gross Margin %
The revenue needed to cover fixed costs, expressed in dollars instead of units.
Worked Example: Fixed costs of $40,000/month. Selling price $50, variable cost $30. Contribution margin: $20. Break-even: 40,000 / 20 = 2,000 units/month, or $100,000 in revenue.
Return and Growth Formulas
Return on Investment (ROI)
ROI (%) = (Net Gain / Cost) × 100
The basic return measurement. Best used for short-term or single-period comparisons.
Annualized ROI (CAGR)
CAGR = [(Final Value / Initial Value)^(1/years)] − 1
Converts cumulative return into the equivalent constant annual rate. Essential for comparing investments of different durations.
Payback Period
Payback Period = Initial Investment / Annual Cash Flow
How long it takes to recover the cost of an investment from the cash it generates. Simple and intuitive; ignores time value of money.
Time Value of Money
Future Value (FV)
FV = PV × (1 + r)^n
What an amount today will be worth in the future, growing at rate r over n periods.
Present Value (PV)
PV = FV / (1 + r)^n
What a future amount is worth today, discounted at rate r over n periods. The basis of nearly all capital budgeting.
Compound Interest
A = P × (1 + r/n)^(nt)
The general compound growth formula with compounding frequency built in. See Compound Interest Explained.
Net Present Value (NPV)
NPV = Σ [Cash Flow_t / (1 + r)^t] − Initial Investment
The sum of all discounted future cash flows minus the upfront cost. Positive NPV means the investment adds value at the chosen discount rate; negative NPV means it destroys value.
Internal Rate of Return (IRR)
The discount rate that makes NPV equal zero. Found by iteration (no closed-form solution). Higher IRR means a more attractive investment, all else equal.
Liquidity and Working Capital
Working Capital
Working Capital = Current Assets − Current Liabilities
The cash and near-cash a business has available to fund day-to-day operations. Positive is healthy; persistently negative is a warning sign.
Current Ratio
Current Ratio = Current Assets / Current Liabilities
A ratio version of working capital. Typical healthy range: 1.5–3.0. Below 1.0 means the business cannot cover short-term obligations with current resources.
Quick Ratio (Acid Test)
Quick Ratio = (Current Assets − Inventory) / Current Liabilities
A stricter liquidity measure that excludes inventory. Inventory can be slow to convert to cash, so this gives a more conservative read.
Cash Conversion Cycle
Cash Conversion Cycle = DSO + DIO − DPO
Days Sales Outstanding (how long until customers pay) plus Days Inventory Outstanding (how long inventory sits) minus Days Payable Outstanding (how long you take to pay suppliers). Lower is better.
Customer Economics
Customer Acquisition Cost (CAC)
CAC = Total Sales + Marketing Spend / New Customers Acquired
The average cost to acquire one new customer over a period. Critical for subscription and recurring-revenue businesses.
Customer Lifetime Value (LTV)
LTV = Average Revenue per Customer × Gross Margin × Average Customer Lifespan
The total gross profit expected from an average customer over their lifetime with the business.
LTV/CAC Ratio
LTV / CAC
A health metric for subscription businesses. Healthy: 3.0 or higher. Below 1.0 means each customer costs more to acquire than they generate.
CAC Payback Period
CAC Payback = CAC / (Monthly Revenue per Customer × Gross Margin)
How many months until a new customer covers the cost of acquiring them. Healthy: under 12 months for most SaaS businesses.
Leverage and Capital Structure
Debt-to-Equity Ratio
D/E = Total Debt / Total Equity
Measures financial leverage. Higher means more debt relative to equity, which amplifies returns and risk.
Interest Coverage Ratio
Interest Coverage = EBIT / Interest Expense
How many times the business's operating profit can cover its interest payments. Below 1.5 is a warning sign; above 3.0 is comfortable.
Debt Service Coverage Ratio (DSCR)
DSCR = Net Operating Income / Debt Service
Common in real estate and small-business lending. Lenders typically want DSCR above 1.25.
Inventory Formulas
Inventory Turnover
Inventory Turnover = COGS / Average Inventory
How many times inventory is sold and replaced per period. Higher means tighter inventory management.
Days Inventory Outstanding (DIO)
DIO = 365 / Inventory Turnover
The same data expressed in days. A turnover of 8 means inventory sits for about 46 days on average.
Pricing Formulas
Selling Price from Margin
Selling Price = Cost / (1 − Margin)
To achieve a target margin, start from cost and divide by 1 minus the margin (as decimal).
Selling Price from Markup
Selling Price = Cost × (1 + Markup)
Faster mental math when starting from a known cost.
Discount Math
Sale Price = Original × (1 − Discount Rate)
Single discount. For stacked discounts, multiply rather than add: Combined Rate = 1 − [(1 − rate1) × (1 − rate2)].
Worked Example: Putting Formulas Together
A small e-commerce business has these numbers for the quarter:
- Revenue: $200,000
- COGS: $80,000
- Operating Expenses: $70,000
- Interest: $3,000
- Taxes: $9,000
- Cash flow from operations: $52,000
- New customers: 800
- Marketing + Sales spend: $24,000
Calculations:
- Gross Margin: (200,000 − 80,000) / 200,000 = 60%
- Operating Profit: 200,000 − 80,000 − 70,000 = $50,000 → Operating Margin 25%
- Net Profit: 50,000 − 3,000 − 9,000 = $38,000 → Net Margin 19%
- CAC: 24,000 / 800 = $30 per customer
- If average revenue per customer = $80 and avg lifespan = 2 years: LTV = 80 × 0.60 × 2 = $96
- LTV/CAC: 96 / 30 = 3.2 ← healthy
This is a profitable, scalable business profile. The same exercise on weaker numbers (say, LTV/CAC of 1.2) would tell you the unit economics are broken and growth would only deepen losses.
Common Mistakes
Confusing margin and markup. A 50% markup is a 33.3% margin.
Reporting ROI without time. A 100% ROI over 10 years is mediocre; over 6 months it is excellent.
Ignoring depreciation in operating profit. Most P&Ls include it; some informal calculations forget it.
Using gross profit as "profit." Gross profit doesn't cover overhead. Net profit is the bottom line.
Calculating LTV with revenue instead of gross profit. LTV should reflect contribution to the business, not top-line revenue.
Treating IRR as the only metric. IRR can favor short, small projects over larger value-creating ones. Use NPV alongside.
When to Use Which
| Decision | Best Formula |
|---|---|
| Setting a price | Margin formula (Selling Price = Cost / (1 − margin)) |
| Evaluating a capital project | NPV with the cost of capital as the discount rate |
| Comparing investment options | Annualized ROI (CAGR) |
| Determining sales volume target | Break-even formula |
| Assessing subscription business health | LTV/CAC ratio and CAC payback |
| Checking liquidity | Current ratio or quick ratio |
| Evaluating debt capacity | Interest coverage and DSCR |
FAQ
What's the most important financial formula for small businesses? Gross margin and break-even. Together they tell you whether each sale is profitable and how many sales you need to keep the lights on.
How do I know which discount rate to use for NPV? Use your weighted average cost of capital (WACC) for company decisions, or your required return for personal investments. Higher discount rates penalize future cash flows more heavily.
Is ROI the same as profit? No. Profit is a dollar amount; ROI is a percentage relative to cost. A high-ROI project on a small base can produce less absolute profit than a low-ROI project on a large base.
What's a healthy LTV/CAC ratio? 3.0 or higher is the common target for subscription businesses. Below 1.0 means each customer loses money; above 5.0 may suggest under-investment in growth.
How does compound interest fit into business decisions? Anything multi-period (investments, loans, capital projects) implicitly uses compounding. Always use compound formulas, not simple multiplication, for analysis longer than one period.
What does break-even actually tell me? The volume of sales required to cover all fixed costs. It is the minimum activity level for profitability and a useful guardrail for pricing and forecasting.
Why are there two ways to calculate selling price? Margin-based (Selling Price = Cost / (1 − Margin)) and markup-based (Selling Price = Cost × (1 + Markup)) produce different prices. Margin is the reporting convention; markup is the operational shortcut.
Related Tools
The Margin Calculator, ROI Calculator, and Break-Even Calculator cover the most frequent formulas. The Compound Interest Calculator handles time-value-of-money scenarios.
Related Articles
Final Thoughts
Financial formulas are tools, not magic. The same handful covers 90% of real business decisions, and the rest live in the specifics of a given industry or contract. Build a reference page, run the same numbers through the same calculators every month, and the trends will tell you more than any single calculation. Discipline and consistency in measurement is worth more than knowing one more obscure ratio.