All right. So let's discuss an important ratio here, earnings per share. So earnings per share is one of the most important ratios. It actually shows up on the income statement. We show it at the bottom. Under net income, they actually show the earnings per share at the bottom of the income statement. So earnings per share, it's going to divide up the current period's net income for all the common stockholders. So they're going to say, okay, we made this much net income. This was the earning per share. Okay? So earnings per share, it's a common profitability ratio and it helps investors make decisions about whether it's a good investment. Right? On how much earnings they're going to get per share of investment. So let's go ahead and dive right into the ratio. See how we calculate it here. Earnings per share, you'll see we commonly use an acronym, EPS, that's how you're going to see earnings per share. EPS, well, it's going to equal net income minus preferred dividends. Now, most of the time, you're not going to deal with preferred dividends and preferred dividends, these are dividends to preferred stockholders. Alright? If you haven't learned too much about equity, don't get too caught up in it. But the preferred dividends usually, what happens is that preferred stockholders get paid first, and then everything else belongs to the common stockholders. Okay? So don't get too caught up in that because most of the time, that's not even going to be there. You're not even going to have to deal with preferred dividends. But it's good to know that our equation, it's net income minus the preferred dividends. And in the denominator, we have the average number of shares of common stock outstanding. And notice, we're talking only about common stock. So it's no price of the stock. We're looking for an actual number of shares. And we're talking about an average number of shares. Technically, this formula uses a weighted average, which is actually a little more complicated than you're going to use in this class. We're just going to use a basic average beginning balance plus ending balance. But once you get to further accounting classes, this calculation actually gets a little more complicated. But for now, we're just going to treat it as the average number of shares of common stock outstanding. So remember, anytime we calculate an average, it's always going to be the beginning balance plus the ending balance. We're going to add those together and divide by 2. And that's exactly what we see in this second formula here. Right? Our numerator stays the same, net income minus preferred dividends. And then in our denominator, we've got our beginning number plus ending number of shares. Remember, we're in the number of shares, not a value. Divided by 2. Cool? And if they just give you one number for shares, they don't tell you a beginning number and an ending number. A lot of times they'll just say, there's a 1,000,000 shares outstanding. Okay? That's going to be your denominator. Alright? You don't have to calculate an average. So what does this ratio tell us? Well, it tells us the amount of income earned for each share. Earnings per share. Right? Our title tells it all. The amount of income per share. So EPS is usually used to analyze trends in a company, right? We want to analyze how is EPS doing year over year. Last year was the EPS bigger than this year. And we want to track how is EPS growing. That's usually a good thing. And remember that investors want more earnings. Investors want more, more, more money. So a higher EPS is always better. They want to be earning as much as possible. Earnings per share, usually want a really high number there. Cool? So what we've just talked about in this calculation for earnings per share, this is what we call basic earnings per share. The basic EPS, Okay? There is another more complicated. Even though this basic EPS calculation can become more complicated, well, there's an even more complicated per share calculation called diluted earnings per share. And guess what? You're not gonna have to do that in this class. So I'm just gonna expose you to it here just so you know what it means. You might get a multiple choice question just asking you about diluted EPS. I doubt that. But I'm just gonna let you know that this is another thing. Just in case you look at a financial statement and you see this, what does it mean? Well diluted EPS, it takes into account the creation of shares, alright? So when we talk about basic EPS, we're talking about just the shares that are outstanding. How many shares people own right now. But there could be other situations where more shares could be created potentially. Alright? And that's what diluted EPS talks about. There could be bonds. You could have some debt that's convertible. A convertible debt that the debt, if they don't want to receive the money back from you, they can convert it into shares of common stock. This is a common form of convertible bonds that can be turned into common stock. And another way that the number of shares could be diluted is employee stock options, right? You've given stock options to employees, they haven't used them yet, but they could, right? And if they use them, there would be more shares. So that would be another way that the EPS could get diluted, alright? Don't get too caught up in that. Focus more on our basic EPS that we talked about. Because remember, we're not gonna have to calculate diluted in this class. We're not going to calculate it. So that's just a little extra knowledge there for you. Alright? So let's go ahead and start calculating basic EPS in these practice problems. Alright? Let's do that now.
Ratios: Earnings Per Share (EPS): Study with Video Lessons, Practice Problems & Examples
Created using AIEarnings per share (EPS) is a key profitability ratio found on the income statement, calculated as EPS=Net Income-Preferred DividendsAverage Number of Shares Outstanding. EPS indicates the income earned per share, guiding investors in their decisions. A higher EPS suggests better profitability, making it a crucial metric for analyzing company performance over time. Understanding basic EPS is essential, while diluted EPS accounts for potential share increases from convertible debt or stock options. Investors typically prefer a higher EPS for better returns.
Ratios: Earnings Per Share (EPS)
Video transcript
MoneyCo had sales revenue and net income during the current year of $500,000 and $60,000, respectively. The total amount of stockholders' equity was $600,000, and common shares outstanding were 120,000 all year. What is MoneyCo's earnings per share?
Tougher Company's current year income statement showed an EPS of $1.25 per share. If total common equity totaled $600,000 (40,000 common shares) and preferred dividends were $10,000 (10,000 preferred shares), what was net income during the period?
Here’s what students ask on this topic:
What is Earnings Per Share (EPS) and why is it important?
Earnings Per Share (EPS) is a key profitability ratio found on the income statement. It is calculated using the formula:
EPS indicates the income earned per share of common stock, helping investors assess a company's profitability. A higher EPS suggests better profitability, making it a crucial metric for analyzing company performance over time. Investors typically prefer a higher EPS as it indicates better returns on their investment.
Created using AIHow do you calculate basic Earnings Per Share (EPS)?
To calculate basic Earnings Per Share (EPS), use the following formula:
First, subtract any preferred dividends from the net income. Then, divide this result by the average number of common shares outstanding. The average number of shares is typically calculated by adding the beginning and ending number of shares and dividing by two.
Created using AIWhat is the difference between basic EPS and diluted EPS?
Basic EPS is calculated using the current number of shares outstanding, while diluted EPS accounts for potential increases in shares. Diluted EPS considers convertible debt, stock options, and other instruments that could convert into common stock, potentially diluting the earnings per share. Basic EPS is simpler and more commonly used, whereas diluted EPS provides a more conservative view of a company's profitability by considering all possible shares.
Created using AIWhy do investors prefer a higher EPS?
Investors prefer a higher EPS because it indicates that a company is more profitable, earning more income per share of common stock. A higher EPS suggests better financial health and potential for higher dividends or stock price appreciation. It helps investors make informed decisions about buying, holding, or selling their shares, aiming for better returns on their investments.
Created using AIHow is the average number of shares outstanding calculated for EPS?
The average number of shares outstanding is calculated by adding the beginning and ending number of common shares for a period and then dividing by two. This provides a simple average, which is used in the EPS formula:
In more advanced accounting, a weighted average may be used, but for basic calculations, the simple average suffices.
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