A company’s financial performance can be measured by using a certain profitability ratio, namely, Cash EPS, which is more commonly known as Cash Earnings per Share. This ratio calculates the cash flows on a per share basis.
By ignoring all of the non-cash items that impact the normal Earning per Share, the Cash Earning per Share provides the analyst with the real earnings that are generated by a certain business.
The Basics of Cash Earnings per Share
A certain company’s underlying performance is measured by this so-called CEPS, as it avoids the accounting leeway that is available to a company. Amortization and depreciation can be on the list of non-cash items that can be found on a company’s financial statements – and they can hide its underlying performance.
Because of this, Cash Earning per Share is able to provide one with a measure of earnings that’s stricter than usual.
Naturally, the higher the CEPS is, the better. It is advised that a company shows an increase in CEPS over the years. As a company has plenty of intangible and tangible assets on its books, the ratio we are talking about becomes more and more important for them.
Because these assets face a payment at a single period, the depreciation charges occur over the life of the assets. Therefore, this kind of charges is considered as being non-cash.
Predicting the annual depreciation charges is not an easy task due to the difficulty that comes with ascertaining the life of a certain asset. Thus, there is a chance that a company might be manipulating this aspect.
The Formula of Cash Earnings per Share
There are two equations through which you can calculate the Cash Earnings per Share. The first one involves the Operating Cash Flow, which is divided by the Number of Shares Outstanding.
The other one is based on the Net Income to which Depreciation and Amortization are added, which are then multiplied by 1-Tax, and then divided by the Number of Shares Outstanding.
The first formula operates with the help of the inclusion of change, which is why the results of these formulas – when calculated for the same company – can have slightly different results. This is why most investors usually rely on the first formula to calculate CEPS.
All of the required factors to solve these equations are found in the notes to accounts and financial statements of the company. An accurate calculation of CEPS is made only when the non-cash elements are identified correctly in the Income Statement.
Using Cash Earnings per Share comes with a great advantage over using normal EPS, as the CEPS is specially adjusted for non-cash items – this allowing the analysts to compare their results and numbers with those of different companies.
If a company has high cash earning, then this might mean that the said company has a strong underlying performance. As an analyst, you would look into the annual growth rate of this profitability ratio – over several years, of course – expecting to find a high growth rate, which is something that every company out there wants.