Basic Earnings Per Share

What is the Basic Earnings Per Share?

Earnings per Share (EPS) is a key metric that helps investors evaluate the financial performance of a company. It is defined as the portion of a company's profit that is allocated to each outstanding share of common stock. In other words, EPS represents the amount of money a shareholder would receive if the company distributed all its earnings to shareholders. In this article, we will discuss the basic concept of EPS, its formula, and solve an example using a fictional company.

Earnings Per Share Formula

The formula for calculating EPS is:

EPS = (Net Income - Dividends on Preferred Stock) / Weighted Average Number of Common Shares Outstanding

Weighted Average Number of Common Shares Outstanding

The Weighted Average Number of Common Shares Outstanding is a key component in the calculation of Earnings per Share (EPS). It represents the average number of common shares that were outstanding over a specific period of time, usually a fiscal year.

The weighted average takes into account any changes in the number of outstanding shares during the period. For example, if a company issues new shares or buys back its own shares, these events will affect the total number of outstanding shares and must be considered in the calculation of the weighted average.

The weighted average is calculated by multiplying the number of shares outstanding for each period by the number of days in that period and then dividing the sum of these products by the total number of days in the period. The resulting number represents the average number of shares outstanding over the entire period.

Example 

In the example that I provided earlier, the Weighted Average Number of Common Shares Outstanding is given as 100,000 shares. So, we don't need to calculate it.

However, if the number of outstanding shares changes during the period, then we would need to calculate the weighted average as follows:

Weighted Average Number of Common Shares Outstanding = (Number of shares outstanding at the beginning of the period x Number of days in that period + Number of shares outstanding at the end of the period x Number of days in that period) / Total number of days in the period.

Let's say, for example, the company ABC Ltd. had 80,000 shares outstanding at the beginning of the period and 120,000 shares outstanding at the end of the period, and the period was 365 days long. Then, the calculation would look like this:

Weighted Average Number of Common Shares Outstanding = (80,000 x 365 + 120,000 x 365) / 365

Weighted Average Number of Common Shares Outstanding = 100,000

So, in this case, the Weighted Average Number of Common Shares Outstanding is 100,000.

The net income is calculated by subtracting the company's expenses from its total revenue. The dividends on preferred stock represent the dividends that are paid to the owners of preferred stock. Preferred stock is a type of stock that has priority over common stock in the payment of dividends and the liquidation of assets.

Earnings Per Share Example

Let's take an example of a fictional company named ABC Ltd. to understand how to calculate EPS. The company has a net income of $1,000,000 and the dividends on preferred stock are $50,000. The weighted average number of common shares outstanding is 100,000 shares. Using this information, we can calculate the EPS as follows:

EPS = ($1,000,000 - $50,000) / 100,000

EPS = $9.50

The EPS of ABC Ltd. is $9.50, which means that if the company distributed all its earnings to shareholders, each shareholder would receive $9.50.

To make it easier to understand, we can solve the EPS example using a table.

Particulars	Amount ($)
Net Income	$1,000,000
Dividends on Preferred Stock	$50,000
Weighted Average Number of Common Shares Outstanding	100,000
EPS	$9.50

From the above table, we can conclude that the EPS of ABC Ltd. is $9.50. This means that the company has a strong financial performance, and its shareholders will receive a good return on their investment.

Conclusion

In conclusion, Earnings per Share is a crucial metric that helps investors evaluate the financial performance of a company. It represents the portion of a company's profit that is allocated to each outstanding share of common stock. The formula for calculating EPS is simple and straightforward, and it involves subtracting the dividends on preferred stock from the net income and dividing the result by the weighted average number of common shares outstanding. By understanding EPS, investors can make informed decisions about investing in a company.