Definition
Earnings available for ordinary shareholders refer to the net profit that a company generates after subtracting all expenses, including taxes and preferred dividends. This amount is available for distribution as dividends to ordinary shareholders. It is a crucial metric for investors, as it provides insight into the profitability and financial health of a company and its ability to pay dividends.
Examples
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Company A: After meeting all its financial obligations, Company A reports a net income of $10 million. The company pays $2 million in preferred dividends. Therefore, the earnings available for ordinary shareholders are $8 million.
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Company B: Another example is Company B, which, after all deductions, reports net earnings of $15 million. If there are no preferred dividends to be paid, the entire $15 million is available for distribution to ordinary shareholders.
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Company C: For a company without any preferred stock, if the net income is $12 million, the earnings available for ordinary shareholders remain $12 million.
Frequently Asked Questions
What are ordinary shareholders?
Ordinary shareholders are the owners of ordinary shares, which represent equity ownership in a company. They have voting rights and typically receive dividends, though these dividends are not guaranteed.
How are earnings available for ordinary shareholders calculated?
To calculate earnings available for ordinary shareholders, subtract preferred dividends from the net income. The formula is:
\[ \text{Earnings Available for Ordinary Shareholders} = \text{Net Income} - \text{Preferred Dividends} \]
Why are earnings available for ordinary shareholders important?
This metric is important because it indicates the amount of profit a company can distribute to its ordinary shareholders as dividends. It also gives insight into the company’s profitability and financial health.
Are retained earnings the same as earnings available for ordinary shareholders?
No, retained earnings are the cumulative profits kept in the company after dividends have been paid, whereas earnings available for ordinary shareholders specifically refer to the current period’s profit that can be distributed as dividends.
What impacts the earnings available for ordinary shareholders?
Factors such as operational efficiency, revenue growth, cost management, and tax obligations impact the earnings available for ordinary shareholders.
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Net Income: The total profit of a company after all expenses have been deducted from revenues.
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Preferred Dividends: Dividends that are paid to preferred shareholders before any dividends are paid to ordinary shareholders.
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Ordinary Shares: Equities representing ownership in a company, which provide voting rights and potential dividend payments.
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Dividends: A portion of a company’s earnings distributed to shareholders.
Online References
- Investopedia: Earnings Available for Common Equity
- Corporate Finance Institute: Earnings Available for Common Shareholders
Suggested Books for Further Studies
- Financial Accounting by Robert Libby, Patricia Libby, and Frank Hodge
- Intermediate Accounting by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
- Accounting Principles by Jerry J. Weygandt, Paul D. Kimmel, and Donald E. Kieso
Accounting Basics: “Earnings Available for Ordinary Shareholders” Fundamentals Quiz
### What is the significance of earnings available for ordinary shareholders?
- [x] It indicates the profit available for distribution as dividends to ordinary shareholders.
- [ ] It represents the total revenue of the company.
- [ ] It includes the company's assets' value.
- [ ] It pertains to the company's gross profit before deductions.
> **Explanation:** Earnings available for ordinary shareholders specifically refer to the portion of net income available for distribution as dividends to ordinary shareholders.
### If a company has no preferred shares, what will be the earnings available for ordinary shareholders in the presence of a net income of $5 million?
- [ ] $4 million
- [ ] $6 million
- [ ] $5 million minus company expenses
- [x] $5 million
> **Explanation:** If there are no preferred shares and dividends, the entire net income is available for distribution to ordinary shareholders.
### Which of the following is deducted from net income to calculate earnings available for ordinary shareholders?
- [ ] Operational Expenses
- [ ] Investments
- [x] Preferred Dividends
- [ ] Depreciation
> **Explanation:** Preferred dividends are deducted from net income to determine the earnings available for ordinary shareholders.
### How would a high preferred dividend payout affect earnings available for ordinary shareholders?
- [x] It reduces the earnings available for ordinary shareholders.
- [ ] It has no effect.
- [ ] It increases the earnings available.
- [ ] It is added to net income.
> **Explanation:** High preferred dividend payouts reduce the net income that remains available for distribution to ordinary shareholders.
### Which financial statement reports earnings available for ordinary shareholders?
- [ ] Balance Sheet
- [ ] Cash Flow Statement
- [ ] Statement of Retained Earnings
- [x] Income Statement
> **Explanation:** The income statement provides net income which, after subtracting preferred dividends, yields the earnings available for ordinary shareholders.
### What is another term for earnings available for ordinary shareholders?
- [ ] Gross Profit
- [x] Net Earnings for Common Equity
- [ ] Operating Income
- [ ] Retained Earnings
> **Explanation:** Earnings available for ordinary shareholders is also known as net earnings for common equity or common shareholders.
### An increase in taxes payable affects earnings available for ordinary shareholders in what way?
- [x] It decreases the earnings available.
- [ ] It increases the earnings available.
- [ ] It has no effect.
- [ ] It doubles the earnings available.
> **Explanation:** An increase in taxes payable reduces net income, thereby decreasing earnings available for ordinary shareholders.
### Which component does NOT directly impact the calculation of earnings available for ordinary shareholders?
- [ ] Net Income
- [ ] Preferred Dividends
- [x] Market Value of Ordinary Shares
- [ ] Operating Expenses
> **Explanation:** The market value of ordinary shares does not directly impact the calculation, which is based on net income and preferred dividends.
### The distinction between preferred and ordinary shareholders is essential for calculating:
- [ ] Gross Margin
- [x] Earnings available for distribution
- [ ] Total Assets
- [ ] Revenue
> **Explanation:** Knowing the distinction is key to understanding how net income is allocated between preferred and ordinary shareholders.
### True or False: The higher the operational efficiency of a company, the higher the potential earnings available for ordinary shareholders.
- [x] True
- [ ] False
> **Explanation:** Higher operational efficiency typically results in increased net income, making more earnings available for ordinary shareholders.
Thank you for exploring the concept of earnings available for ordinary shareholders and tackling our insightful quiz. Stay financially informed!
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