Earnings Meaning
Earnings is usually defined as the net income of the company which is obtained after reducing the cost of sales, operating expenses, interest and taxes from all the sales revenue for a specific time period. In case of an individual, it comprises of wages or salaries or other payments.
Explanation
Earnings of a company are crucial determinant since it calculates the share price of the company. Share price determines the going concern of the company according to the profitability capabilities. It helps in determining whether it will be profitable in the long run or not. These are the most critical measure for stakeholders that have a massive impact on their decisions towards the company. It helps in making the comparison, derive estimates, and analyze past trends of the company with the industry.
How are Earnings Calculated?
They are generally determined as earnings available for the shareholders of the company. From the after-tax profitsAfter-tax ProfitsProfit After Tax is the revenue left after deducting the business expenses and tax liabilities. This profit is reflected in the Profit & Loss statement of the business.read more of the company, the profits shared with the senior class of shareholders of the company have to be subtracted like preference shareholders. The remaining profits are the company’s profits available for the shareholders, which shall be distributed among shareholders in ratio.
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For eg:
Source: Earnings (wallstreetmojo.com)
Example
For example, a company has after-tax profits of $100,000. The company has 1,000 preferred shareholders who are guaranteed dividends of $ 30 per year and 10,000 common stock shareholders. In this case, the guaranteed dividend to the preferred shareholders is distributed first from the after-tax profits. The dividend distributed is $ 30,000, which is subtracted from after-tax profits. The remaining $ 70,000 profits are the earnings available for the common stock shareholders.
Measures
Commonly, the earnings are measured by reducing the cost of sales, operating expenses, and taxes from all the sales revenue for a specific period. They are measured in different ways, depending on the analysts. The most common measure of profitability is the calculation of earnings per shareEarnings Per ShareEarnings Per Share (EPS) is a key financial metric that investors use to assess a company's performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is.read more. The other measures are Earnings Before Taxes (EBTEBTPretax income is a company's net earnings calculated after deducting all the expenses, including cash expenses like salary expense, interest expense, and non-cash expenses like depreciation and other charges from the total revenue generated before deducting the income tax expense.read more), Earnings Before Interest and Taxes (EBITEBITEarnings before interest and tax (EBIT) refers to the company's operating profit that is acquired after deducting all the expenses except the interest and tax expenses from the revenue. It denotes the organization's profit from business operations while excluding all taxes and costs of capital.read more), Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDAEBITDAEBITDA refers to earnings of the business before deducting interest expense, tax expense, depreciation and amortization expenses, and is used to see the actual business earnings and performance-based only from the core operations of the business, as well as to compare the business's performance with that of its competitors.read more). The analysts use such measures based on their purpose and requirements. The ratios are also calculated to determine the earnings of an organization like EPS, PE RatioPE RatioThe price to earnings (PE) ratio measures the relative value of the corporate stocks, i.e., whether it is undervalued or overvalued. It is calculated as the proportion of the current price per share to the earnings per share. read more, yield, etc.
Importance
Earnings are an essential measure for all the stakeholders of the company to review their decisions. Above all, investors are highly affected by the net income of a company as it drives stock prices. It tells about the financial health of a company and the value of the stock of the company. The dividends are paid to the shareholders based on the net income of the company.
Earnings vs. Profits
- In general language, the earnings and profits are treated as synonyms. In the financial industry, both terms are not the same.
- These are the company’s bottom lineBottom LineThe bottom line refers to the net earnings or profit a company generates from its business operations in a particular accounting period that appears at the end of the income statement. A company adopts strategies to reduce costs or raise income to improve its bottom line. read more profits calculated after deduction of all the expenses. Whereas, profits are used with respect to income statement measuring gross profitsGross ProfitsGross Profit shows the earnings of the business entity from its core business activity i.e. the profit of the company that is arrived after deducting all the direct expenses like raw material cost, labor cost, etc. from the direct income generated from the sale of its goods and services.read more, operating profits, and net profits.
- Profits are commonly used in the calculation of ratios concerning profit margins to analyze a company’s income statement and operating activitiesOperating ActivitiesOperating activities generate the majority of the company's cash flows since they are directly linked to the company's core business activities such as sales, distribution, and production.read more.
- For example, ABC Ltd. Made sales of 10,000 units at $10 per unit. The revenue of the company is $ 100,000. The operational costs and expenses involved in preparing the finished units are $ 70,000. Therefore, the profits of the company are $ 30,000, i.e., the profits earned after reducing operational costs from the sales revenueSales RevenueSales revenue refers to the income generated by any business entity by selling its goods or providing its services during the normal course of its operations. It is reported annually, quarterly or monthly as the case may be in the business entity's income statement/profit & loss account.read more. But, the earnings of the company would be calculated after further deducting the costs and expenses of debt sources, taxes, etc.
Conclusion
It has been concluded that earnings are the final and net income of a company after reducing all the operating expensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit.read more as well as other debt-related costs and taxes. They are the final income available in the hands of the shareholders. These are not similar to the profits of the company.
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