Question

Discuss the difference between basic earnings per share and fully diluted earnings per share giving examples of items that would make up the difference.

Answer 1

Basic earnings per share is a ratio that quantifies the amount of money available to equity shareholders of a company :-

Its calculated as (net profit - preferred dividends /Number of shares)

There are various instruments like convertible bonds, share warrants, employee stock options which have the right that they can be exercised in a number of stocks. Thus they affect the basic earnings per share and is called diluted earnings per share.

Example - lets take the example of convertible debt- lets say the option on debt is exercised and the number of stocks get increased but the net profit is also increased as the debt is reduced now so no interest is paid.

Final formula - (net profit-preferred dividends+ income from dikution saved) /adjusted equity shares)