Hello and welcome everyone to our lesson today. In today's lesson, we will discuss the single accounting number that is reported most frequently in the media and cited and receives by far the most attention by investors and creditors, EPS, earnings per share. The reasons for the considerable attention paid to earnings per share certainly include the desire to find a way to summarize all the performance of a business throughout a certain period in just one single simple number, EPS. Let's get it started in details because the calculation of the EPS, depending on the capital structure of the firm. We are going to start with what we call simple capital structure. A firm is set to have a simple capital structure if it has no outstanding securities that could potentially dilute, and when we say dilute mean reduce earnings-per-share. With a simple capital structure, the calculation of basic earnings per share is merrily firm's net income or net loss obviously, divided by the number of shares of common stock outstanding throughout the year. Simply stated in a very simple equation, EPS is calculated, as you can see in front of you, net income or loss divided by the number of common shares outstanding. Obviously, the calculation becomes more challenging and will require more calculations when some situation is up. I will summarize for now four situations that will complicate or will need to be considered when we calculate EPS and it's the simplest form that we have had before. The first one, when the firm has outstanding preferred stock that is qualified to receive dividends. In this case, the earnings available to common shareholders are diminished by the dividends that are paid to those preferred shareholders. Remember that dividends preferred to pay shareholders is not an net income component and that's why you're reducing the net income by this preferred dividends to take what is available to the common stockholders to calculate the EPS. Second one, when the number of shares has changed during the reporting period by selling or purchasing of stock during the reporting period. In this situation also, we will calculate something called a weighted average number of shares. We will see later how do we calculate exactly this weighted average number of shares where we weighted by the time the shares were outstanding. Third scenario or third situation. When a stock distribution, dividend or stock split, occurs during the reporting period. In such case, any sale or purchase of shares that occur before that starting solution, but not after, should be adjusted to incorporate the distribution in the calculation. We'll see that again in details just in few minutes, how to do this adjustment. Fourth and final situation where it complicate the earnings per share calculation. When the firm has a complex capital structure where various outstanding securities can give rise to potential common shares. It's 'If' conditional statement. If something happens, then the number of shares outstanding will increase. In such a case, the firm is required to additionally calculate a diluted EPS to incorporate the dilutive effect of all the potential common shares that can be issued because of those potential security. We will focus our attention in this lesson, as I said, on simple capital structure by incorporating the first three previous challenges, only the three, we're going to exclude the fourth one, which is the complex capital structure for a later discussion. But for now, we are going to incorporate the three complications that we talked about. Having said so, what are we going to do? Here you go. The EPS, as you can see in the question in front of you, in the numerator, did you notice that the change now I have the earnings available to common shareholders because I am going to deduct the preferred dividends from the net income. I have in the numerator earnings available to common shareholders and in the denominator now I have weighted average number of common shareholders outstanding. As we talked about, the earnings available to common shareholders will be the net income minus preferred dividends, because the preferred dividends is not an expense, is not a component of net income. That is why I will further deduct it to calculate the available net income for whatever the common stockholder will be able to claim. What about the weighted average number of common shares outstanding? The weighted average number of common shares outstanding, as you can see in the question in front of you, equals the shares outstanding at the beginning of the period, plus any shares issued during the period. But those shares that are issued during the period, have to be time weighted for the fraction of the year that they are outstanding, and we will deduct the shares that were reacquired during the period. Again, will be time weighted for the fraction of the year that they were not outstanding during the period. In the case of the firm making any stock distributions during the year and that's the third complication, any shares sale or repurchase before, not after the stock distribution should be adjusted by the percentage of the stock distribution. For example, if it's a 10 percent stock distribution, then I'll take all the shares outstanding and were issued or reacquired before that stock distribution of 10 percent and multiply it by 10 percent, 1.1, we'll see the calculations in later lessons. In summary, the weighted average number of shares is increased by any shares that are issued and is reduced by any shares that are reacquired during the period. The number of shares will be time weighted for the fraction of the year that they were outstanding or not outstanding for those that were reacquired. When a stock distribution or a stock dividend occurs during the reporting period, any shares that were existing, outstanding, any sale, any repurchase, any of those changes and the shares that had occurred before the distribution, but not that distribution, will be adjusted by the distribution that was announced. Thank you.
