Earnings definition
/What are Earnings?
Earnings are the profits generated by a business. The generation of earnings is a key driving force behind the formation and subsequent operation of a business. Earnings can then be used to pay dividends to shareholders. If a company is still growing and does not have sufficient cash to distribute as dividends, earnings might instead be held within the business; if so, investors can profit from an increase in the market value of the company stock that they hold.
How to Calculate Earnings
Earnings are derived by subtracting the cost of goods sold, operating expenses, and taxes from revenue. The revenue figure in this calculation is net of any sales returns and allowances. The formula is as follows:
Revenue - Cost of goods sold - Operating expenses = Earnings
Patterns in Earnings Generation
Earnings tend to be quite low or negative during the early years of a business, when it is spending money to build products and services, as well as to expand its market presence. Once the business is established, its earnings are typically both larger and more consistent. If the decision is made to run down and liquidate a business, it is possible that earnings will briefly be quite high, since the sales and marketing expenses that it usually incurs to maintain market share among customers are no longer being incurred. Thus, there is a definite pattern to the timing of earnings generation over the life of a business.
Impact of Earnings on Stock Prices
If a company is publicly held, the amount of earnings reported is a significant driver of its stock price. If the amount is lower than expected by analysts, the stock price could drop sharply, even though the amount may meet or exceed the company's own expectations. Conversely, a reported earnings level greater than analyst expectations could result in a notable increase in the stock price.
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How to Report Fraudulent Earnings
A company’s management may fraudulently alter a company’s earnings. They may reduce reported earnings in order to defer the payment of income taxes, or report increased earnings in order to trigger a jump in the firm’s stock price. Earnings can be adjusted in many ways. One approach is to defer the recognition of supplier invoices, thereby shifting reported expenses into a later period. Another approach is to falsely alter depreciation calculations, in order to defer or accelerate depreciation expense. Yet another option is to fake the ending inventory balance, which is used in the cost of goods sold calculation; the ending balance reported can alter earnings either up or down.
Terms Similar to Earnings
Earnings is also known as income.
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