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 share. The other measures are Earnings Before Taxes (EBT), 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 (EBITDA). 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 line profits calculated after deduction of all the expenses. Whereas, profits are used with respect to income statement measuring gross profits, 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 activities.
- 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 revenue. 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 expenses 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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