Three Basic Factors of Earnings

Three Basic Factors of Earnings:  Two businesses for sale could report the same numeric value for “earnings” and yet be far from equal. Three factors of earnings are listed below that tell more about the earnings than just the number.

1. Quality of earnings
Quality of earnings measures whether the earnings are padded with a lot of “add backs” or one-time events, such as a sale of real estate, resulting in an earnings figure which does not accurately reflect the true earning power of the company’s operations. It is not unusual for companies to have “some” non-recurring expenses every year, whether for a new roof on the plant, a hefty lawsuit, a write-down of inventory, etc. Beware of the business appraiser that restructures the earnings without “any” allowances for extraordinary items.

2. Sustainability of earnings after the acquisition
The key question a buyer often considers is whether he or she is acquiring a company at the apex of its business cycle or if the earnings will continue to grow at the previous rate.

3. Verification of information
The concern for the buyer is whether the information is accurate, timely, and relatively unbiased. Has the company allowed for possible product returns or allowed for uncollectable receivables? Is the seller above-board, or are there skeletons in the closet?

Why Earnings are Important

Earnings are an important measure for public companies, because investors base investment decisions on earnings, and stock price is based on earnings.Stocks Expert Ken Little says that earnings are an important indicator of company health. While earnings reports must be taken in context, earnings per share are the best way to measure the value of a company’s stock.

Earnings are important to shareholders, because dividends are paid based on annual earnings.

Earnings in Investment and Stock Price

Earnings are expressed in different ways for purposes of investing. Here are some common investment terms associated with the term “earnings.”

Factors of Earnings:

Earnings per share (EPS) (net profit divided by number of shares) is used for publicly held companies who have actively traded stock. The earnings per share figure is probably the most used financial calculation. IEPS one way to analyze the company’s value. Earnings per share is calculated as:

Total net income available to common shareholders (shareholders of common stock) divided by the number of common shareholders. 

Factors of Earnings:  EBITDA stands for “Earnings before interest and taxes, depreciation and amortization.” This earnings calculation includes only sales minus cost of goods sold and general and administrative expenses. EBITDA is a description of the profit the company would have had if it didn’t have to pay interest expenses on business debts, and any taxes, and before any calculations for depreciation and amortization.

Contact us today:

MGL Business Solutions – Cincinnati, Ohio 45248

Mike Lohbeck, CBI

Phone: (513) 200-0247



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