Cash Earnings Per Share (EPS) is a metric that reflects how much operating cash flow a company has generated in a given period of time per each outstanding share it has. It is essentially a similar calculation to the more popular Earnings Per Share, yet, the net income is adjusted for changes in working capital, depreciation and amortization.
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The purpose of the Cash Earnings per Share metric is to determine how much of the profits generated by the business have actually been cashed in. This helps analysts avoid misleading conclusions on companies that inflate revenues through certain obscure accounting methods in an effort to boost share prices and trigger compensation plans for top executives.
A declining Cash Earnings per Share metrics indicate that the business is not being able to produce enough cash, which is essential to finance growth. While a consistent increase in Earnings Per Share (EPS) is a positive sign, if it is not accompanied by a parallel growth in the Cash Earnings per Share (Cash EPS), the profits indicated on the income statement may not be a realistic indication that the business is performing well.
The Cash Earnings per Share formula is calculated like this:
Cash EPS = Operating Cash Flow / Diluted Shares Outstanding
Cash EPS Equation Components
Operating Cash Flow: The result of adding back depreciation and amortization charges to net income, along with the net change in working capital.
Diluted Shares Outstanding: The number of shares currently circulating and in the hands of shareholders, including potential new shares originated if all outstanding stock options, warrants and convertible issues are excercised.
Cash EPS Example
Bread & Butter LLC is a company that operate dozens of restaurants located across the U.S. East Coast. These restaurants offer simple meals, coffee, milkshakes, pound cakes, and other dishes that are suitable for either breakfast, lunch, brunch or even dinner.
The company has been operating for 22 years and a few days ago they published their annual report where the company reported $2.6 in Diluted Earnings per Share. Additionally, the company also reported a net income of $6,184,360, a total number of shares outstanding of 2,028,600, not including 350,000 new shares that can be generated if the current stock options and convertible issues are exercised.
Depreciation and amortization charges totaled $1,288,000 and changes in working capital resulted in -$3,443,000. Using this information, an analyst can estimate the Cash EPS for Bread & Butter LLC.
Cash EPS = ($6,184,360 + $1,288,000 – $3,443,000) / (2,028,600 + 350,000) = $1.69
The reported Earnings per Share ($2.6) is significantly higher than the Cash EPS ($1.69), which means the company only cashed in on a portion of those earnings, as a significant portion of it were consumed by a decreased in accounts payable, since increased its inventory substantially to save money by buying bigger volumes from suppliers.
Breaking down the Operating Cash Flow employed for the Cash EPS formula is particularly important to understand the reason with the Cash EPS may be different than the EPS. For example, if the reason why there’s a difference is related to a significant amount of depreciation and amortization charges, it is important for the analyst to identify which assets are requiring such large charges. On the other hand, if the difference is related to a negative working capital change, then a further evaluation of which accounts affected the current working capital would be advisable in order to spot any potential issues that may be draining the company’s cash.
The Cash EPS can also be employed for comparison purposes, if the analyst decides to evaluate the business’ performance with that of peer companies. This comparison should be made between companies of similar sizes in terms of sales, market capitalization and even better if they operate in the same or in similar industries. For comparison purposes, the metric can be divided by the current market price of the shares in order to estimate the return on investment in cash terms, not just profits. Additionally, many different items can be also estimate on a per share basis, such as fixed assets, total assets or sales. Dividing the Cash EPS by any of these ‘per share’ figures will yield great insights into the performance of the business assets and the overall profitability of the company in cash terms and performing the same calculations on similar companies will lead to useful conclusions on how competitive or efficient the company is compared to its peers.
Determining the effect that stock warrants, options and convertible issues will have on the number of outstanding shares is crucial to estimate the Cash EPS, especially if the analysis will include a comparison of previous years. The fully diluted Cash EPS must be calculated on each year that is part of the analysis, to make sure the conclusions drafted from the comparison are accurate.
The best scenario for any company would be that the Cash EPS is higher than the EPS. That indicates that the business is cashing in on its profits and that provides the necessary capital for further expansion. On the contrary, if the business Cash EPS only represents a small percentage of the diluted EPS, then it means that even though the business appears to be profitable, it is not going to be able to take full advantage of those profits to finance further projects, as the available cash is being eaten by working capital changes.
Cash EPS Uses, Cautions, and Pitfalls
When it comes to comparing the EPS vs. the Cash EPS, both figures must be calculated by using the same number of outstanding shares. Employing different number of shares on each calculation will lead to a distortion of the results and therefore to misleading or inaccurate analysis.
Also, a common mistake would be to compare companies by their Cash EPS, without consider other elements into the comparison. The Cash EPS is directly related to the number of outstanding shares a company has. A company with a lower Cash EPS than others doesn’t necessarily produce less money. It may be that the company has issued more shares and the Cash EPS is diluted because of that higher volume.