The standard computation for earnings per share only looks at the company's currently issued common shares and the company's earnings. However, an alternative calculation, fully diluted earnings per share, also called diluted net income per common share, measures the company's earnings if all common stock equivalents and convertible shares were to be converted into common stock. For example, some preferred shares allow the holder to convert preferred shares into common shares and some bonds give the holder the option of converting the bond into common shares.
Divide the company's earnings for the year by the number of common shares outstanding to find the company's earnings per share. For example, if the company has $1.8 million in earnings and 200,000 in common shares, divide $1.8 million by 200,000 common shares to get $9 in earnings per share.
Add the number of common stock shares to the number of common share equivalents and convertible securities to find the adjusted shares outstanding. For example, if the company has 200,000 common shares, 50,000 preferred shares that can be converted to common shares at a one-to-one ratio, and a bond that can be converted to 20,000 common shares, add 200,000 plus 50,000 plus 20,000 to reach 270,000 adjusted shares outstanding.
Subtract any tax benefit from the bonds from the interest paid out by the company on the bonds. For example, if the company pays $400,000 in interest and the holder gets a $100,000 tax benefit from owning the bonds, subtract $100,000 from $400,000 to find the effective cost of the bonds, which equals $300,000.
Add the effective cost of the bonds to the company's earnings for the year to calculate the company's adjusted earnings for the year. In this example, add $300,000 to $1.8 million to reach adjusted earnings of $2.1 million.
Divide the adjusted earnings by the adjusted shares outstanding. Select the lower of that result and the standard earnings per share to find the fully diluted earnings per share. In this example, divide $2.1 million by 270,000 to reach $7.78 per share. Since $7.78 is less than $9, the diluted net income per common share equals $7.78 per share.
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