Key Corporate Finance Formulas

Corporate finance relies on a variety of formulas to make informed decisions about investments, funding, and company value. Understanding these formulas is crucial for effective financial management.

Valuation Formulas

Net Present Value (NPV)

The NPV calculates the present value of expected cash flows, discounted by the required rate of return.

Formula: NPV = Σ [CF_t / (1 + r)^t] – Initial Investment

• CF_t: Cash flow in period t
• r: Discount rate (cost of capital)
• t: Time period

A positive NPV indicates a profitable investment.

Internal Rate of Return (IRR)

The IRR is the discount rate that makes the NPV of all cash flows from a particular project equal to zero.

It’s solved iteratively, not directly calculated.

If IRR > Cost of Capital, the project is generally considered acceptable.

Profitability Formulas

Gross Profit Margin

Measures the percentage of revenue remaining after deducting the cost of goods sold.

Formula: Gross Profit Margin = (Revenue – Cost of Goods Sold) / Revenue

Operating Profit Margin

Measures the percentage of revenue remaining after deducting operating expenses (excluding interest and taxes).

Formula: Operating Profit Margin = Operating Income / Revenue

Net Profit Margin

Measures the percentage of revenue remaining after deducting all expenses, including interest and taxes.

Formula: Net Profit Margin = Net Income / Revenue

Leverage Formulas

Debt-to-Equity Ratio

Measures the proportion of debt used to finance a company’s assets relative to the value of shareholders’ equity.

Formula: Debt-to-Equity Ratio = Total Debt / Shareholders’ Equity

Times Interest Earned (TIE) Ratio

Indicates a company’s ability to cover its interest expense with its earnings.

Formula: Times Interest Earned = Earnings Before Interest and Taxes (EBIT) / Interest Expense

Working Capital Management Formulas

Current Ratio

Measures a company’s ability to pay its short-term liabilities with its short-term assets.

Formula: Current Ratio = Current Assets / Current Liabilities

Quick Ratio (Acid-Test Ratio)

A more conservative measure of liquidity, excluding inventory from current assets.

Formula: Quick Ratio = (Current Assets – Inventory) / Current Liabilities

Return on Investment (ROI) Formulas

Return on Equity (ROE)

Measures how efficiently a company is using shareholder investments to generate profits.

Formula: Return on Equity = Net Income / Shareholders’ Equity

Return on Assets (ROA)

Measures how efficiently a company is using its assets to generate profits.

Formula: Return on Assets = Net Income / Total Assets

These are just a few of the essential corporate finance formulas. Their application depends on the specific context and goals of the analysis. It’s important to understand the underlying principles and assumptions behind each formula to use them effectively.