Earnings are the lifeblood of any business. Without them, a business would be unable to attract investors and would likely close in short order.
But exactly how earnings are calculated can be a somewhat complicated matter in the world of business. Here's what you need to know about earnings and how they impact a business.
What Are Earnings?
The earnings definition is simple, but the concept of earnings has many uses.
The earnings of an individual are money that person receives for work or business ownership.
The earnings of a business are the same as its net income or profit. These terms all mean essentially the same thing.
What are Net Earnings?
Net earnings are used more than the term "earnings."
The net earnings of an individual are earnings after mandatory withholding and deductions (like FICA taxes and federal income tax).
Net earnings of a business are earnings minus expenses, taxes, and deductions. More precisely, net earnings = revenues (sales) – cost of sales, operating expenses, and taxes, over a given period of time.
Two Other Types of Earnings for Businesses
These two types of earnings are basically saying the same thing, but you might see one or both of them in a corporation's annual report or other documents.
Accumulated earnings are the net profits of a corporation that are not given to shareholders as dividends. They are reinvested into the company.
Retained earnings are the total of all net income earned by the company over its life, less any distributions to shareholders.
The Retained earnings amount is shown on the business balance sheet as equity (ownership) because it represents amounts of income that aren't needed to pay bills and are available to shareholders.
Why Earnings Are Important
Earnings are an important measure for public companies (those that offer shares of stock to the public) because investors base investment decisions on earnings, and stock price is based on earnings. While earnings reports must be taken in context, earnings per share are the best way to measure the value of a company's stock.
Earnings and Taxes
Earnings are also important to small businesses for tax reasons. The business described above has earnings of $100,000. The earnings are used to calculate:
Income taxes. The net taxable amount is calculated on Schedule C for a sole proprietorship, for the purpose of calculating individual income taxes. If the business is a corporation, earnings are included on the corporate income tax return, and the corporation's taxes are calculated using this figure.
Self-employment taxes. For small business owners who must pay self-employment tax (Social Security, Medicare tax), the net earnings (called net profit or loss) of the business are the basis for this calculation.
Earned Income – TwoTypes of Earnings
A term closely related to earnings is "earned income." this type of income comes from
- Working for someone who pays you and receiving wages, salary, tips, and other taxable employee compensation, or
- Being self-employed and owning or running a business.
Earned income doesn't include interest and dividends, pensions or annuities, Social Security, unemployment benefits, alimony, or child support.
Earnings in Investment and Stock Price
Earnings are expressed in different ways for the purposes of investing.
Earnings per share (EPS) refers to net profit divided by the number of shares, is used for publicly held companies who have actively traded stock. The earnings per share figure is probably the most used financial calculation. EPS is one way to analyze the company's value.