Financial Accounting

Learn the toughest concepts covered in your Financial Accounting class with step-by-step video tutorials and practice problems.

Table of contents
14. Financial Statement Analysis

Ratios: Earnings Per Share (EPS)


Ratios: Earnings Per Share (EPS)

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Alright 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 uh at the bottom of the income statement. So earnings per share, it's gonna divide up the current periods net income for all the common stockholders. So they're gonna say okay we made this 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 gonna get per share of investment. So let's go ahead and dive right into the ratio. See how we calculated here earnings per share. You'll see we we commonly uh acronym, a common acronym used here is E. P. S. That's how you're gonna see earnings per share. E. P. S. Well it's gonna equal net income minus preferred dividends. Now, most of the time you're not gonna 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 stock holders 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 gonna be there, you're not even gonna have to deal with preferred dividends. But it's good to know that that our equation, its 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 the shares of common stock, we're not talking about the value of the stock, no price of the stock, nothing like that. 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 gonna use a basic average beginning balance plus ending balance. But once you get to further accounting classes, this this calculation actually gets a little more complicated, but for now we're just gonna treat it as the average number of shares of common stock outstanding. So remember anytime we calculate an average, it's always gonna be the beginning balance plus the ending balance, we're gonna add those together and divide by two. 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 of shares plus ending number of shares. Remember we're in a number of shares, not a value divided by two. 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 million shares outstanding. Okay. That's gonna 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 E. P. S. Is usually used to analyze trends in a company, right? We want to analyze how is E. P. S. Doing year over year? Last year was the E. P. S bigger than this year. And we want to track how is E. P. S. Growing. That's usually a good thing. And remember that investors want more earnings, investors want more and more and more money. So a higher Cps is always better. They want to be earning as much as possible earnings per share. Usually want a really high number. They're cool. So we've just talked about in this calculation for earnings per share. This is what we call basic earnings per share. The basic E. P. S. Okay, There is another more complicated even though this basic GPS calculation can become more complicated. Well, there's an even more complicated earnings 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 E. P. S. 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 gPS it takes into account for the creation of shares. Alright. So when we talk about basic E. P. S. 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. All right. And that's what diluted GPS talks about. There could be bonds. You could have some debt that's convertible a convertible debt that the debt if they don't they could just instead of receiving the money back from you, they can they can convert it into shares of common stock. This is a common uh This is a common debt form of convertible convertible stock. Excuse me, convertible bonds that can be turned into common stock. And another way that the a number of shares could be diluted. And when we say diluted is that there's actually more shares than it actually shows in the basic E. P. S. What could be employee stock options, right? You've given stock options to employees. They haven't used them yet, but they you could write and if they use them there would be more shares. So that would be another way that the E. P. S. Could get diluted. All right. Don't get too caught up in that focus more on our basic gps that we talked about, because remember we're not going to 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. All right. So let's go ahead and start calculating basic gps in these practice problems. Alright, let's do that now.

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?