Earnings is one of those words possessing a double meaning when examined closely but only a single meaning when its alter-ego is used in conversation. Income is the alter-ego. Income is analogous to both people and companies. It is calculated differently but it is needed by both entities to survive and prosper. Income to people is most often their paycheck. It is figured a bit differently from a company’s earnings but the bottom line is the same. For example, with a paycheck the gross amount is computed by multiplying the hours worked by the hourly wage.
While that is the most common means, some people work on commission or a base pay plus commission or a flat salary. Regardless after all deductions for taxes, insurance, loans, etc, the bottom line is the take home pay. Companies on the other hand compute income by taking their revenues and subtracting cost of sales, operating expenses and taxes over a given period of time. A company’s earnings usually refer to after-tax net income.
Notice the similarity between a person’s income and a company’s income. Both are after tax numbers. This number is the actual earnings because all of the mandatory “deductions” have been accounted for. Notice also the computation method does not indicate how a person or company will spend their earnings. Nor, does it intimate that these earnings will be spent wisely or foolishly.
One can easily surmise that if a person spends their earnings foolishly or haphazardly their personal life style will suffer. Almost the same thing can be said for a company because, generally, a business’s earnings are the main determinant of its share price. If a company is not publicly traded and does not maintain a reserve set aside out of earnings, it probably won’t maintain profitability. Its remaining economic life could be shortened considerably without attention to and maintenance of earnings.
Regardless of which category one is looking at when it comes to earnings, it is clear successful longevity can only be insured by the constant evaluation of income/earnings. Not minding the store (to use an old saying), almost always leads to earnings dwindling and longevity evaporating.
EARNINGS PER SHARE (EPS)
Earnings per Share (abbreviated to EPS) is the amount of profit put aside by a company for each outstanding share of common stock. It is simply a ratio that measures a company’s earnings (profit after tax) divided by the number of ordinary shares. This can be used to measure a company’s profit performance over time. It also shows the potential for paying out dividends to shareholders.
Earnings per share can be easily calculated with the following formula:
Earnings per Share = net profit after tax / number of ordinary shares.
Earnings per share is relatively meaningless if analyzed on its own, although the higher the result the better for shareholders themselves. Meaning can only be established by comparing the previous year’s results, to see how the company has developed.
What is often ignored when using the earnings per share ratio is the amount of initial investment needed to pull in the net income listed in the calculation. For example several businesses might end up with the same earnings per share amount, but company A might reach the number using less initial funds than the other companies. This suggests that company A is a more efficient business and therefore more stable and safer to invest in.
There are several types of EPS number used in analysis. These include:
Trailing EPS – which is the previous year’s number and is often compared with the current EPS Current EPS – is this year’s number. Forward EPS – is a forecast of what the number might be in the future.
EBITDA
EBITDA is the abbreviation of Earnings Before Interest, Taxes, Depreciation and Amortization. This refers to a method of measuring a business’s financial performance. The full calculation is:
EBITDA = Revenue– Expenses (excluding interest, tax, depreciation and amortization).
EBITDA is often used to study and evaluate profit and performance against the competition and similar industries. It is affective because it ignores things like depreciation and other financial conclusions, by looking at the raw revenue and expenses.
Despite this EBITDA is not a credited calculation by the Generally Accepted Accounting Principles (GAAP), because it is easy to include only some revenues and expenses. In other words it can be calculated how a business wants to do it, leaving it open for bias, and there is nothing stopping a company including one item in one quarter and another in the next to make it look better; there is no consistency.
EBITDA does not represent cash earnings. It is a good evaluation of profits and is often used in the accounting as a method to “window dress” the earnings, so they can be touted in a positive press release. This is not illegal, but can be deemed unethical.
The EBITDA measure is of high interest to a company’s creditors and banks. It is basically the income that a business has free for repayment of loans and other debt. In fact when it first started being used in the 1980’s, it was applied solely to demonstrate a company’s ability to pay off debt.
ECONOMY
An economy consists of every activity involved with the production of goods and services in a town, region or country.
ECONOMIC INDICATOR
Statistical measures of current conditions in an economy. “Leading” economic indicators such as those that track consumer confidence, factory orders, or money supply may signal short term economic strength or weakness. “Lagging” economic indicators such as business spending or unemployment figures move up or down as the economy strengthens or weakens. Economic indicators together provide a picture of the overall health of an economy or economic zone and how bond prices and yields might be affected.
ECONOMIC RISK
Economic risk describes the vulnerability of a bond to downturns in the economy. For example, virtually all types of high-yield bonds are vulnerable to economic risk. In recessions, high-yield bonds typically lose more principal value than investment-grade bonds. If investors grow anxious about holding low-quality bonds, they may trade them for the higher-quality debt, such as government bonds and investment-grade corporate bonds. This “flight to quality” particularly impacts high-yield issuers.
ECONOMIES OF SCALE
Factors which cause the average cost of a unit to fall as the amount of output increases. So in a table factory the cost to make one table decreases as more wood is bought and more tables are made. This often happens as companies receive discounts when buying materials in bulk. The opposite of this is known as diseconomies of scale.
When a company grows there are certain things it can do more efficiently. The group term for these factors is “economies of scale.” When a company experience economies of scale their production costs fall. For example:
A game console company can produce 100 consoles for $30 each, but when they hit the 1000 mark, they can make them for $25 each because of economies of scale. If the console sells in stores for $100 then the company will see the profit margin rise from $70 to $75 per console.
Economy of scale is therefore, in effect, a benefit of being a big company that can produce products to the masses. This is often why small businesses cannot keep up with the big commercial brands, because they don’t see the same savings.
Bulk buying and the ability to take on long term contracts are the most common form of economy of scale, but there are others. These include Technical Economies (where larger companies can afford to invest in more efficient technology and machinery), Managerial Economies (when big companies can employ very specialized staff), Financial Economies (banks and lenders are more likely to give loans to large companies) and marketing economies (when bigger companies have more money to use on more effective marketing methods).
On the flip side diseconomies of scale might occur when one supplier can no longer meet a company’s high demand, so they have to go to a more expensive alternative or when expanding means utilizing more expensive machinery to meet demand.
EMBEDDED OPTION
A provision that gives the issuer or bondholder an option, but not the obligation, to take an action against the other party. The most common embedded option is a call option, giving the issuer the right to call, or redeem, the principal of a bond before the scheduled maturity date.
EMERGING MARKET BONDS
Emerging market bonds usually include government (or “sovereign”) bonds; sub-sovereign bonds and corporate bonds. Domestic emerging market bonds-those issued within an emerging market country-make up about ¾ of the amount of debt in the emerging market bond markets but because it can be difficult for a variety of reasons to trade in domestic emerging bonds, emerging market bonds held by foreign investors are usually foreign or external emerging market bonds. The majority of external emerging market bonds are government bonds.
ENTERPRISE VALUE
Enterprise value is calculated by adding together a company’s market capitalization, its debt such as bonds and bank loans, other liabilities such as a pension fund deficit and subtracting liquid assets like cash and investments. It is the theoretical price to takeover a company, the price to acquire it free of debt and other liabilities.
EQUITY
In real estate equity refers to how much “real” value is tied up in the house, which the owner actually owns outright. In other words how much of the house they own in comparison with how much is still left outstanding in the mortgage.
EQUITY PLACEMENTS
Searching for the most profitable way to finance one’s business is a question of major significance nowadays. Equity placements are a quite recognizable and preferred way of capital injection, reaching its peak period between the years 2005-2007. In 2007 alone, $686 billion of private equity were invested around the globe, nearly doubling the investments made in 2005.
The popularity of equity placements among entrepreneurs and developers has encouraged the establishment of companies that specifically deal with equity transactions and solutions. Qualifying for a traditional loan from a bank could be problematic and time consuming, especially for a starting business. Therefore, it is crucial to find the right way to present your product to potential investors, especially if you are not publicly registered on a stock exchange, so as to obtain new capital. Companies that specialize in equity transactions will carry out the entire process of the placement, selecting investors and business owners whose financial plans and aims make a perfect match. This long process involves several phases. In the beginning, a detailed resume of the company’s structure, business plan, financial model, and future projects is prepared, focusing on the benefits and advantages of investing capital in its business activities. The resume is then presented to carefully chosen potential investors and finally, the preliminary agreements and other paperwork are signed. According to the Private Equity International magazine, the number 1 private equity firm for 2009 was TPG, followed by Goldman Sachs Capital Partners, the Carlyle Group, Kohlberg Kravis Roberts, and Apollo Global management, being the top five. Private equity firms usually operate through private equity funds, established by the general partner and an investment advisor. Over a period of 3 to 5 years, the firm establishes a new equity fund.
There are several investment strategies to keep in mind if you consider investing in private equity. These are usually used by investors – mezzanine capital, leveraged buyouts, venture capital and growth capital. Venture capital refers to equity capital which is provided to companies in early stages of development, in the beginning of the life cycle of a new product or a technology. Due to the fact that investing in an unknown product is risky and uncertain, investors receive high returns as compensation for the risk they had taken. Growth capital stands for equity investment in established companies that are looking for ways to enlarge their production capacity or enter new markets. Although the company may have already reached a reasonable profit level, it is usually unwise to fund major expansions on its own, without additional equity placements. Growth capital is also used to restructure the balance sheet of a company and in particular, as means to reduce the amount of debt the company has incurred. Growth capital may be structured in the form of preferred or common equity. The capital is provided by buyout firms, growth capital firms, and venture capital investors.
Mezzanine capital refers to subordinated debt which is payable after all other debts if a company closes. Mezzanine capital is either in the form of debt or preferred stock. This form of financing is typically used by small size companies and involves greater leverage levels. Leveraged buyout refers to the use of significant amount of borrowed capital for the acquisition of a company. In the typical case, the assets of the new company are used as collateral so that loan is granted for its acquisition. Leveraged buyouts help companies to carry out acquisitions without investing huge amounts of capital. The ratio between debt and equity is usually 90:10. The bonds that are issued for a leveraged buyout are called junk bonds due to the considerable risk involved in them.
EQUITY SWAP
In an equity swap two parties agree to exchange future cash flows linked to the performance of a stock or stock index. One cash flow, or leg, is usually linked to a market interest rate, the other to a stock or stock index performance. For example, party A swaps $10 million at Libor plus 5 basis points for six months with party B who agrees to pay any percentage increase in $10 million invested in the S&P500. In six months party A will owe the interest on the $10 million but this will be offset by the percentage increase in the S&P500 multiplied by $10 million. If the S&P500 falls then party A will owe the percentage fall multiplied by $10 million in addition to the interest payment.
ESTATE
Estate is a term that is often applied to a large collection of real estate, or a big piece of property owned by person or family. However in actuality a person’s estate is everything they own; all of their assets, real estate, land, other forms of property and liabilities. It is often defined as the net worth of somebody at any given time.
People often consider their wealth as the money they have in the bank, but this is not strictly true. Money is only a small part of somebody’s estate. Your house is part of your estate, as is your widescreen television and your bicycle sitting in storage. If you sold everything you own, including your house and investments, added the money in your bank and then took away any liabilities, this would be closer to your true estate. Think of it as the formula:
Cash + Assets + Investments – Liabilities = Estate.
The term estate is also often used in the process of inheritance. For example “the young master inherited the grand estate of his father.” This simply means either through a will or default, the son inherited everything his father owned, including liabilities; this must be taken out of the inheritance.
If somebody goes bankrupt, aka, they cannot pay off all of their debts; it can have significant consequences for the person’s estate. Anything they own which is deemed valuable enough to pay off debts can be auctioned and sold. The most common in this situation is the person’s house.
In real estate, the singular term estate may also refer to just housing and land, more specifically the houses, extensions, buildings, land and gardens, woodlands, and farmland that is owned by one person, family or interest, on one joined plot of land.
EUROBOND
Eurobonds are bonds that are denominated in a currency other than that of the European country in which they are issued. They are usually issued in more than one country of issue and traded across international financial centers. Supranational organizations and corporations are major issuers in the Eurobond market.
EURO-ZONE
The European Union Countries that use the Euro as the single currency and in which a single monetary policy is conducted under the responsibility of the European Central Bank. In sharing a common currency, the member states of the European Economic and Monetary Union (EMU) are governed by the same monetary policy but this uniformity does not extend at the country level to alignment of all economic, regulatory and fiscal matters, including matters of taxation.
EVALUATOR
An independent service responsible for appraising the value of securities in a trust’s portfolio.
EVENT RISK
Company and industry “event” risk encompasses a variety of pitfalls that can affect a company’s ability to repay its debt obligations on time. These include poor management, changes in management, failure to anticipate shifts in the company’s markets, rising costs of raw materials, regulations and new competition. Another kind of event risk is the possibility of natural or manmade disasters affecting an issuer’s ability to repay its obligations. Events that adversely affect a whole industry may have a spillover effect on the bonds of issuers in that industry.
EXCESS SPREAD
The net amount of interest payments from the underlying assets after bondholders and expenses are paid and after all losses are covered. Excess spread may be paid into a reserve account and used as a partial credit enhancement or it may be released to the seller or the originator of the assets.
EXCHANGEABLE BOND
A bond with an option to exchange it for shares in a company other than the issuer.
EXCHANGE-TRADED FUND
A fund that tracks an index, a commodity or a basket of assets. It is passively-managed like an index fund, but traded like a stock on an exchange, experiencing price changes throughout the day as they are bought and sold. Bond ETFs like bond mutual funds hold a portfolio of bonds and can differ widely in their investment strategies.
Exchange Traded Funds (abbreviated ETF) are similar to stock, as they are traded on stock exchange, but unlike stock they act as a security that tracks a series of assets, commodities or an index itself. Their value fluctuates every day as they are traded.
Pretty much anything you can do with regular stock, such as selling short, you can do with exchange traded funds and because they are listed on exchanges like normal stock they can be traded at any moment in the day unlike most types of mutual funds.
Similar to any other types of stock an EFT’s value might change from hour to hour, and investors will usually trade through a broker so that they can purchase them, which means a commission will have to be paid to the broker for the purchase. Because EFT’s track indexes they usually have lower transaction costs and operating costs, and they are also more tax efficient than other types of securities.
“The Spider” is one of the most common exchange traded funds. Abbreviated SPDR this fund tracks the S & P 500 index and is denoted by the SPY symbol. It was also the first ever EFT created, beginning trading in 1993.
Some opposers of exchange traded funds claim that they are sometimes used to control and manipulate the market and some experts even gone as far as to claim that they may have been partly to blame for the market collapse in 2008.
EXPECTED RETURN
The average of a probability distribution of possible returns.
EXPENSE RATIO
The ratio of total expenses to net assets of a mutual fund. Expenses include management fees, 12(b) 1 charges, if any, the cost of shareholder mailings and other administrative expenses. The ratio is listed in a fund’s prospectus. Expense ratios may be a function of a fund’s size rather than of its success in controlling expenses.
EXTENSION RISK
The risk that investors’ principal will be committed for a longer period of time than expected. In the context of mortgage- or asset-backed securities, this may be due to rising interest rates or other factors that slow the rate at which loans are repaid.
EXTRAORDINARY REDEMPTION
This redemption is different from optional redemption or mandatory redemption in that it occurs under an unusual circumstance such as destruction of the facility financed.
EXPENSE
In the broadest sense, expense is the opposite of revenue, but it is not limited to that meaning. Expense is the money you sacrifice in order to gain revenue. To earn a maximum profit, companies make an effort to cut down on expenses without reducing revenues. Types of expenses include salaries to staff, depreciation of capital assets, payments to suppliers, factory leases, interest expense for loans, and utilities. Buying assets such as equipment or building is not considered an expense. Expenses increase the liabilities or decrease the assets. If expenses are recorded to a liability or asset account as a credit (balance sheet account) and to an expense account as a debit (income statement account), then the procedure is referred to as double-entry bookkeeping. This system was established in the 15th century and involves at least two different accounts for transactions and events. The equity equals liabilities subtracted from assets. The system is characterized by credits and debts – if the sum of debits does not equal that of credits, it can be assumed that a mistake has been made.
Expenses are divided into financing expenses, investing or capital expenses, and operating expenses in statements of cash flow. Financing expenses involve interest costs for bonds and loans. Capital expenses refer to purchasing equipment and other material facilities, while operating expenses are salary payments. Not all “expenses”, however, are considered as such. For example, expenses subject to depreciation are considered such only if the business entity employs accrual accounting. Most big companies and corporations make use of it. This system records items when they are gained. Deductions are made when expenditures are incurred.
How does one determine when income is earned? There are two ways, known as the earlier-of test and the all-events test. With the former, the taxpayer gains income when payment is due, payment is made (depending on which one occurs earlier), and when the required performance has occurred. With the latter, income is included for the tax year when its amount of income can be accurately determined.
To find out the costs of goods sold, businesses have to value their inventory at the beginning and the end date of every tax year. The cost of goods sold should be deducted from the company’s gross receipts to come up with its annual gross profit. Some expenses included in figuring the cost include: direct labor costs (e.g. contributions to annuity plans and pensions) for workers involved in the production process; the cost of raw materials or products, together with freight; storage; and factory overhead. In compliance with the uniform capitalization rules, direct costs and some of the indirect costs for resale activities and production must be capitalized. Indirect costs include: purchasing, storage, taxes, interest, rent, processing, handling, repacking, and administrative costs. This rule does not hold for personal property that is acquired for the purpose of resale if one’s gross receipts per annum, for 3 consecutive tax years, are less than $10 million.
Under the US tax code, buying gas to fuel assets, such as a business car, is considered an expense whereas the actual car is not. This is because it is a business-related asset and as such, it also represents a capital expense. Costs that prolong or improve the life of such assets are not considered expenses and are not tax-deductible. Gas will only allow the car to run. Expenses also include costs that reduce taxable income.
EURO
The euro is the EU’s single currency. It was introduced as the EU’s unit of account in 1999 by the 11 euro zone countries that joined stage three of EMU. Euro notes and coins were introduced in 2002. Sixteen countries use the euro as of 2009.
401K PLAN
A tax-deferred retirement plan that can be offered by businesses of any kind. A company’s 401k plan can be a “cash election” profit-sharing or stock bonus plan, or a salary reduction plan. A 401k plan carries many unique advantages for both employer and employee.
403(b) Plan
SECTION 403(b) of the Internal Revenue Code allows employees of public school systems and certain charitable and nonprofit organizations to establish tax-deferred retirement plans which can be funded with mutual fund shares.
404(c)
Optional regulation on plan sponsor to provide certain information and fund choices so plan participants can make informed decisions about their retirement plan investments.
