Earnings Per Share (EPS) is a key financial metric that indicates the profitability of a company attributed to each outstanding share of common stock. EPS is calculated using the company’s consolidated profit for the period after deducting minority interests and preference share dividends and dividing this figure by the weighted average number of ordinary shares in issue during the period.
Calculation of EPS
EPS can be calculated on a net basis or a nil basis:
- Net Basis: Includes variable tax elements like unrelieved overseas tax arising from the payment or proposed payment of dividends.
- Nil Basis: Excludes such variable tax elements from the tax charge.
The EPS should be clearly shown on the face of the profit and loss account for the period reviewed and the corresponding previous period. The methodology used for EPS calculation must be disclosed either on the face of the profit and loss account or in the notes to the accounts.
Importance of EPS
Initially, EPS was a crucial performance measure, especially prominent in the 1950s and 1960s. However, its significance has somewhat declined over time. Currently, UK listed companies and entities that choose to disclose an EPS figure need to comply with International Accounting Standard (IAS) 33, which mandates the disclosure of both basic EPS and fully diluted EPS on the profit and loss account.
Examples
Example 1
Company A reported a net income of $500,000 for the year. There were 100,000 outstanding shares throughout the year. The EPS is calculated as follows:
\[ \text{EPS} = \frac{\text{Net Income}}{\text{Weighted Average Shares Outstanding}} = \frac{500,000}{100,000} = 5.00 \]
Example 2
Company B had inconsistent share counts due to issuing shares mid-year. If they had 80,000 shares for the first half and issued an additional 40,000 shares for the second half, the weighted average shares outstanding are calculated as:
\[ 80,000 \times \frac{6}{12} + 120,000 \times \frac{6}{12} = 40,000 + 60,000 = 100,000 \]
If their net income was $600,000, EPS would be:
\[ \text{EPS} = \frac{600,000}{100,000} = 6.00 \]
Frequently Asked Questions (FAQs)
What is Basic EPS?
Basic EPS is calculated by dividing the net income by the weighted average number of ordinary shares outstanding during the reporting period.
What is Fully Diluted EPS?
Fully Diluted EPS considers the potential conversion of all dilutive securities into ordinary shares, reducing EPS due to the increased share count.
Why is EPS important?
EPS provides investors with a snapshot of a company’s profitability on a per-share basis, aiding in the comparison between companies or across different reporting periods.
What factors can affect EPS?
Factors include net income changes, share buybacks, new share issues, dividend payments, and tax rate modifications.
How does EPS relate to stock price?
EPS is often used in conjunction with price-to-earnings (P/E) ratio to evaluate a company’s valuation. Higher EPS reflects improved profitability and can positively impact the stock price.
Related Terms and Definitions
Minority Interests
The portion of a subsidiary company’s equity not owned by the parent company.
Preference Share
A type of ownership in a company that has a higher claim on assets and earnings than common stock.
Profit and Loss Account
A financial statement summarizing revenues, costs, and expenses of a company during a specific period.
Consolidated Profit
Aggregate profit of parent and subsidiary companies.
International Accounting Standard (IAS) 33
Standards ensuring consistency in financial reporting, specifically governing the calculation and presentation of EPS.
Online References
Suggested Books for Further Studies
- “Wiley GAAP 2022: Interpretation and Application of Generally Accepted Accounting Principles” by Joanne M. Flood
- “Financial Accounting Theory and Analysis: Text and Cases” by Richard G. Schroeder, Myrtle W. Clark, and Jack M. Cathey
- “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
Accounting Basics: Earnings Per Share Fundamentals Quiz
Thank you for embarking on this journey through our comprehensive accounting lexicon and tackling our challenging sample exam quiz questions. Keep striving for excellence in your financial knowledge!
