The average shares outstanding concept is used to calculate earnings per share information. The averages shares outstanding is inserted into the denominator of the earnings per share calculation, to derive the earnings per share in a reporting period. This information is only reported by publicly-held companies; it is not necessary to report this information for privately-held, governmental, or nonprofit entities.
The calculation of average shares outstanding is essentially a weighted average calculation, which results in a more accurate averaging outcome than if a simple averaging calculation were to have been used.
For example, a business has 100,000 shares outstanding at the beginning of January. It then issues 40,000 shares at the beginning of February, and 20,000 shares at the beginning of March. By the end of March, the total shares outstanding figure is 160,000. To calculate the average shares outstanding, we assume there were 100,000 shares outstanding in all of January, 140,000 shares outstanding in all of February, and 160,000 shares outstanding in all of March. When these three months are aggregated, the result is 400,000 shares. When we divide this figure by the three months of the measurement period, the average shares outstanding is 133,333 shares.
If a simple average had instead been used in the example, we would have added the beginning share balance to the ending share balance and divided by two, which would have resulted in an average shares figure of 130,000 shares.