Every corporate firm needs to understand its current financial position in the market. In terms of the corporate language, their financial liquidity is to be measured in regular intervals to ensure their existence in the business. A firm that issues stock is advised to analyze its profitability. A firm needs to understand the absolute profit that it earns through the trading of stocks in the market.
To analyze the profit earned by a company on a per-share basis Earnings Per Share is calculated by the company.
What is Earnings Per Share (EPS)?
Earnings Per Share is the concept used to analyze the income of the company from each share of the company. Furthermore, earnings per share can be defined as the understanding of the company’s financial position concerning the profit gained from each share issued to the investors.
Not only the company can understand the shareholder’s contribution to the company, but the investors can also analyze the future aspects and the financial position of the company by analyzing the EPS at different times during the company run.
The position of the EPS determines the stability and profitability of the company. The profitability and the EPS are directly proportional to each other. The greater the EPS the higher the profit. And if profits are higher there is higher dividend distribution among the shareholders.
EPS is usually calculated with the following formula
EPS= Net Income after Tax/Total Number of Outstanding Shares
EPS= (Net Income − Preferred Dividends)/End-of-Period Common Shares Outstanding
Importance of Earnings Per Share
As mentioned earlier it is ideal to calculate EPS over some time to analyze the past, understand the current stands, and anticipate the future trends through which the firm has to undergo. It is an inevitable part of a firm to calculate EPS so that the firm prolongs in the market and has the financial stability to continue business for a foreseen future. The following are the reasons why EPS is considered an important part of business happenings:
- EPS over a period helps the company to analyze its profitability spread and if the EPS is higher there is a high chance of a higher dividend payout.
- EPS helps the shareholders to analyze and prospect the return they can gain from investing in that particular investment.
- If the company shows a constant increase in the EPS the investors will be more attracted to invest in the shares of that company.
- EPS acts as a base to calculate different financial ratios to analyze the financial position of the firm. The main ratio is price earnings ratio which relies upon the EPS of the company.
- The company calculates EPS so that it can keep track of the past performances of the firm and compare the performance with other companies.
Even though EPS is considered really important EPS does not consider the inflation factor and companies manipulate the data for short-term gain. The EPS does not consider the cash flow position and sometimes high EPS companies may be on the edge of debt.
Types of Earnings Per Share
Reported EPS or GAAP EPS
Just like the name suggest it is recorded based on Generally Accepted Accounting Principles. These figures are derived from the accounting principles of the company. This includes the one-time payment done by the company in different portfolios.
Ongoing EPS or Pro Forma EPS
In this type one-time payments made by the company are excluded. It includes activities that are considered core and affect the long-term functioning of the firm. This helps in anticipation of income in the future.
Carrying Value or Book Value EPS
Under this type, the real cash value of the shares is analyzed by the company. It is usually calculated based on the current balance sheet values of the company.
The amount the company keeps with them after distributing the dividends is known as retained earnings. Retained EPS is used to understand how the profit management of the company is taking place.
It is calculated as follows.
Earnings Per Share Formula
= (Net earnings + current retained earnings) – divided paid /
total number of outstanding shares
This is calculated to understand what amount is earned by the company from the shares traded. It is one of the truest versions of EPS as manipulation is difficult in the actual figures earned by the company. It is calculated as follows:
Cash EPS = Operating Cash Flow/Diluted Shares Outstanding
A firm needs to understand its financial position in numerical terms. The most suitable way to understand this is by calculating the earnings per share earned by the company. Earnings per share help the company to understand the gain from the trade as well as the investors an idea of what they will earn if they invest in this particular company. Earnings per share play a vital role not only in company profitability management but also aids to investment planning of the shareholders.