Earnings per share for xyz Company - Term Paper Example

?Earnings per share for xyz Company Introduction In most settings, basically earnings per share refer to a company’s earning or loss divided by the total number of the outstanding shares. Most publicly owned companies like XYZ Company, according to the Generally Accepted Accounting Principles (GAAP), are required to report Earnings per Share in their income statements. They normally give Earning per share a certain distinction among the financial ratios. Earnings per share are considered very important in a business since it allows the investors to know how much the business earned in their stock share investment. In other words, EPS shows how much in terms of net income did the business earned for each stock share owned. Basic EPS Ratio The essential EPS is given by the equation; EPS = Net Income / Total number of stock share (Wiley, 2013). For example, in the following income statement, the company’s $32.47 million net income is divided by the 8.5 million shares of stock it owns to get the $3.82 EPS. Income statement for the year 2010 Sales revenue $457,000 Cost of goods sold expense $298,750 Gross Margin $158,250 Sales, Administration and general expense 102, 680 Earnings before interest and income tax $55,570 Interest expense 6,250 Earnings before income tax $49,320 Income tax expense 16,850 Net income $32,470 Basic earnings per share $3,82 Diluted earnings per share $3,61 EPS = 32.47million/8.5million = $3.82 For the stakeholders of businesses whose shares are publicly traded, EPS becomes extraordinarily important. The stakeholders therefore need to pay close attention to the market price per share. In such cases, the stakeholders would prefer their net income to be communicated to them in terms of per share so that they can be able to compare it with the market price of the stock per share (Bryan, 2011). Unlike publicly owned companies, the stock shares of privately owned companies are not traded actively. This is because they do not have to report their EPS according to the GAAP. This exemption is explained by the fact that their stockholders do not focus on per share values but are instead interested in the business’s net income. The Diluted EPS Ratio The XYZ Company could be listed in the New York Stock Exchange (NYSE) given the assumption that its shares are traded at $70 per share. Well known as the Big Board, requires that requires that the market capital which includes the total of the shares issued and the outstanding shares, should be at the least, $100 million and the number of shares available for trading should be at least 1.1 million. The Company’s market capital is $595 million with the 8.5 million shares trading at $70 per share and this is well above the NYSE’s minimum. By the end of the year, this company has 8.5 million shares just outstanding. This number refers to the number of stock shares that have been issues and are now owned by its stakeholders. Therefore, the Earnings per share is $3.82 as has been computed. Nevertheless, a complication sets in when the business is committed to issuing additional capital stock shares in the future for stock options granted to the executives by the company, and it has funds borrowed on the basis of debt instruments. This particularly gives the lenders the right to convert the debt into its capital stock. Following that, the business may have to issue 500,000 additional capital stock shares in the future under terms of its management options as well as its convertible debts. When we divide the net income by the number of the outstanding shares plus the additional shares that could be issued in the future, the following EPS computation emerges; $32.47million net income ? 9million capital stock shares issued and potentially issuable = $3.61 EPS This second computation, as can be seen, has higher number of stock shares and is therefore referred to as diluted earnings per share. The term diluted is used to refer to thinned out or spread over a large number of shares. That notwithstanding, the first computation being based on the number of stock shares actually issued and outstanding, is referred to as basic earnings per share. Both the two types of earnings per share are reported at the bottom of an income statement. This makes publicly owned companies to have two EPS figures unless the companies are simple capital structures that it does not need to issue additional stock shares in the future. From what is normally the case, most of the publicly owned companies have complex capital structures and therefore have to report two EPS figures at the bottom of an income statement. It is very important to note that basic EPS ignores the dilutive effect of potential common shares. On the other hand, dilutive EPS combines or incorporates the dilutive effects of potential common shares. We include the dilutive effect after we assume that the securities already have been exercised, converted or if not, transformed into common shares. Most of the time in press releases and articles, it is mostly confused which figure is used, one has to be careful on which figure is used and which one is being used in the calculation of the price/Earnings (P/E) ratio. Adjusting the EPS Ratio Calculating basic and adjusted EPS values are is not just as easy as it can be perceived, there are certain complication factors that accountants require to adjust before they may calculate the EPS values. Some of these complication factors include: 1) Issuance of additional stock shares and buying back of some of its stock shares In this situation, the weighted average number of outstanding stock is used. 2) Issuance of more than one type of stock, causing net income to be divided into two or more pools-one pool for each kind of stock. Earnings per share refer to the common stock or the most junior of the classes of stock issued by a business. An earnings per share is always compared from year to year in the same company for the purposes of trend analysis. However, EPS is not used to compare companies since the values per share normally differs. Instead, to compare companies, Price/ Earnings (P/E) ratio is normally used to compare companies. The XYZ company above has revenues of $457,000 and expenses of $407, 680 for the period. Retained earnings will be increased by the following closing journal entry: Date General Journal Debit Credit Income summary $49,320 Retained Earnings Summary $49,320 Since there is a normal balance of retained earnings, this is called a credit balance and as we know, a credit increases the stockholder’s equity therefore, revenues must exceed expenses. When expenses exceed the revenues, this is a case of net loss and if the company undergoes through a case like that for the first year of operation or over a period of years, the retained earnings account may go to a debit balance and this is called deficit (Moneli). In a situation where the net income is large enough, the Board of Directors may declare a dividend of $10,000 like the one illustrated here below: this is a cash dividend payable to stock holders. Date General Journal Debit Credit Retained Earnings $10,000 Dividends Payable $10,000 When dividend is paid in cash, the following journal entry is made: Date General Journal Debit Credit Retained Earnings $10,000 Cash $10,000 Net activity (NA) is normally equated to the owner’s equity since NA is normally given by total holdings of the company – the total shares held. Therefore, NA =Equity. Conclusion Earnings per share is normally a very vital tool in a business as its analysis over a period of years may be used to indicate the flow of the business profitability and whether a business is making profits or loss. One should not use earnings per share of one company to compare it to the other company since companies differ in the amount of common stock share held or issued. EPS is calculated by dividing the net income by the total common shares outstanding and there is the basic and diluted earnings per share usually reported at the bottom of the any income statement belonging to most publicly owned companies. References Bryan, K. (2011). Chron. Formular for Calculating the Earnings Available for Common Stakeholders , 1-2. Moneli. (n.d.). Retrieved October 9, 2013, from Lesson 14-Dividends and Retained Earnings: http://seattlecentral.edu/faculty/moneil/A220/L15/Horngren14.htm Wiley, B. (2013). Accounting for Dummies. Calculating theEarning per Share (EPS) Ratio , 1 3. Read More