Earnings available for common stockholders definition

/

What is Earnings Available for Common Stockholders?

Earnings available for common stockholders is a measure of the amount of earnings that a business could pay out to the owners of its common stock. It is calculated as net after-tax profits, minus any preferred dividends. Preferred dividends must be subtracted from profits, because this is an obligation of the business before it can issue any dividends to its common stockholders. The formula is as follows:

Net after-tax profits - Preferred dividends = Earnings available for common stockholders

However, the reported amount of earnings may be higher than the amount of cash reserves of the business, so the firm might not actually be able to issue the indicated amount to shareholders. In addition, management might need the cash for internal uses, and so may have no plans to issue any dividends to common stockholders.

When to Use Earnings Available for Common Stockholders

The measure is more relevant in industries that do not require large investments in working capital or fixed assets, such as the service industry. Conversely, when large investments are required, the calculated amount of earnings available for common stockholders may not be payable at all, and in fact the business may be adding debt in order to better fund the needs of the organization. The measure is especially not useful when a business is growing rapidly, since the entity will need all of its cash (and more) to fund the increased amounts of receivables and inventory that accompany growth. in short, you need to understand the context of a business within its growth cycle before relying on the earnings available for common stockholders.

Related AccountingTools Course

The Interpretation of Financial Statements

Examples of Earnings Available for Common Stockholders

Here are several examples of earnings available for common stockholders:

  • Small corporation example. A small business reports net after-tax profit of $100,000 and also pays a $10,000 dividend on its outstanding preferred stock. This means there are $90,000 of earnings available for common stockholders.

  • Large corporation example. A large business reports operating earnings of $20 billion, interest expense of $5 billion, taxes of $3 billion, and preferred dividends of $1 billion. The firm’s net income is therefore $12 billion, from which the preferred dividends figure is then subtracted. This means that the business has $11 billion of earnings available for common stockholders.