One way investors and managers measure company performance is through financial ratios, one of which is earnings per share. To calculate EPS, the corporation divides net income -- after subtracting dividends paid on preferred stock shares -- by the weighted average number of common shares, which equals the number of outstanding shares prorated by the fraction of the year that they existed.
Pro-Rated Weights
The "weight" in weighted average shares is a fraction of a year. At year's end, the corporation begins the calculation of weighted average shares by listing the beginning balance of shares, followed by the dates and changes to the share balance. The fraction of the year that each new balance existed becomes its weight, which is multiplied by the new balance to form its weighted average. The year-end weighted average shares is the sum of the all the year's weighted averages.
Example Calculation
Suppose a corporation has a beginning balance of 900,000 common shares, and then issues another 300,000 on May 1, giving it 1.2 million outstanding shares. The beginning balance of 900,000 shares was operative for four months, giving it a pro-rated weighted average of ((4/12) x 900,000), or 300,000 shares. For the eight months from May 1 through Dec. 31, the weighted average shares was ((8/12) x 1.2 million), or 800,000 shares. Summing the two weighted averages gives the year-end weighted average shares: 300,000 + 800,000, or 1.1 million. This is the number to use as the denominator in the EPS calculation.