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Explain Earnings per share (EPS) in financial management.
Earnings per Share (EPS) are a financial measure that tells about net earnings of a shareholder over a period. In other words, EPS is part of profit distributed to the shareholder. EPS tells whether company can produce net profit for shareholders.
It tells about financial health of a company. If EPS is high, it states that company is earning more profits and have ability to distribute those profits to shareholders. If EPS is low, it states that company earnings are not as expected.
Categories of EPS are −
- Trailing EPS − Based on previous year’s numbers.
- Current EPS − Based on present or current numbers.
- Forward EPS − Based on projected or anticipated numbers.
EPS Variations are given below −
- GAAP EPS − Calculates as per GAAP guidelines.
- Pro forma EPS − Excludes one-time income from net income.
- Retained EPS − Tells about part of profit hold (not distributed as dividends).
- Cash EPS − Tells about cash earned.
- Book value EPS − Calculates company’s equity in each share.
- Basic: Earnings per share (EPS) = (P-Pd)/WACS
- Based on net income: Earnings per share (EPS) = (NI-Pd)/ACS
- Based on operations: Earnings per share (EPS) = (Oi-Pd)/WACS
Here, P = profit, Pd = preferred dividends, WACS = Weighted average common shares, NI = net income,
Oi = income from operations, ACS = Average common shares.
Importance of EPS is explained below −
- Tells investors about income generating capacity of a company.
- Investors can compare between companies and made their choice.
- Can anticipate stock value.
- Can track previous performances.
Limitations of EPS are as follows −
- Can manipulate EPS value.
- Inflation is not considered.
- Cash flow is not considered.
- Infective to gauge company’s solvency.
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