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I am having 2 objects "account" and "contact" with common field "city" which is a lookup field. If i update city field in account (eg:mumbai to chennai) it must update it in all fields of contacts to mumabai to chennai in contacts also. How can i do it using formula fields

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Just create a formula filed on contact object and get the value from Account City. No need to use City of Contact level. This is what you can achieve otherwise you have to go with apex trigger to achieve the same.

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