Earnings Per Share Explained: Calculating Basic and Diluted EPS With a £2m Profit and 500,000 Share Options

If you run a growing SME, or manage the finances for one, you have probably been asked at some point, ‘what is this company actually worth per share?’ The answer usually starts with earnings per share, or EPS. But if your business has issued share options to directors or key staff, a single EPS figure can be misleading. Investors, banks and potential buyers will want to know not just what the company earned per share today, but what happens if everyone holding an option decides to exercise it. This article walks through exactly that scenario, using a company with £2 million profit and 500,000 outstanding share options, so you can see how basic and diluted EPS are worked out and why the difference matters.

What Earnings Per Share Actually Tells You

EPS is simply the company’s profit divided by the number of shares in issue. It turns a lump sum profit figure into something comparable across companies of different sizes, and it is one of the first numbers investors look at when judging whether a business is performing well relative to its share price. For an SME owner, EPS becomes especially relevant when you are raising investment, preparing for a sale, or reporting under UK GAAP or IFRS where disclosure of EPS may be expected by stakeholders or provided voluntarily, even though unlisted companies are not legally required to present it.

Basic EPS: The Starting Point

Basic EPS answers a straightforward question: for every share currently in issue, how much profit did the company generate? Take our example company. It made a profit after tax of £2,000,000 for the year, and it has 10,000,000 ordinary shares in issue, unchanged throughout the period for simplicity. The calculation is simply profit divided by shares.

So, on a basic measure, each share ‘earned’ 20 pence of profit for the year. That figure alone looks clean and simple. The complication arrives when you remember that this business has also granted 500,000 share options to employees. Those options are not shares yet, but they could become shares, and that possibility needs to be reflected somewhere in the reporting.

Why Share Options Change the Picture

A share option gives someone the right to buy a share later, usually at a fixed price set when the option was granted. If the option holder exercises that right, the company issues new shares, and the total number of shares in issue goes up. More shares means the same profit gets divided among a larger pool, so earnings per share typically falls. This is called dilution, and it is precisely why accounting standards require companies presenting EPS that have potentially dilutive instruments, such as options, convertible loans or warrants, to disclose a second figure: diluted EPS.

Working Out Diluted EPS Step by Step

Under IAS 33 (which entities reporting under UK GAAP must also apply if they choose or are required to present EPS), you do not simply add all 500,000 option shares to the share count. Instead, you use what is often called the treasury stock method. The logic is that if option holders pay to exercise their options, the company receives cash, and that cash could theoretically be used to buy back some shares at the current market price. Only the ‘net’ extra shares, after accounting for that assumed buyback, are treated as dilutive.

Let us assume the options have an exercise price of £1.00 each, and the average market price of the shares during the year was £2.00. Here is how the dilution calculation works through in practice.

The key insight here is that only 250,000 of the 500,000 options actually dilute the share count, because the other half is effectively ‘funded’ by the cash the company receives when the options are exercised. With the diluted share count established, the diluted EPS calculation follows the same logic as basic EPS, just with a larger denominator.

So basic EPS of 20.0p falls to diluted EPS of 19.5p once the potential effect of the share options is taken into account. That half a penny difference might look small, but across millions of shares, and in a valuation built on a price-to-earnings multiple, it can represent a meaningful difference in perceived value.

What This Means for Your Business

If you are an SME owner with a growing option pool for senior staff, or a finance manager preparing reports for investors, EPS is not just a compliance exercise. It is a direct signal of how much future dilution your existing shareholders are exposed to. A company that looks highly profitable on a basic EPS basis can look noticeably less attractive once diluted EPS is calculated properly, particularly if the option pool is large relative to the existing share base. This matters most at three points: when you are raising external investment, when you are preparing financial statements under IFRS or UK GAAP and choose to present EPS (or are preparing for a public listing where EPS disclosure is mandatory), and when you are negotiating a sale or exit, where a buyer will almost always ask for the fully diluted position before agreeing a price per share.

1. Always calculate both basic and diluted EPS if your company has any share options, warrants or convertible instruments outstanding, even if you are not legally required to disclose EPS.
2. Use the weighted average number of shares in issue during the period, not the figure at the balance sheet date, to avoid overstating or understating EPS.
3. Apply the treasury stock method properly: only the incremental shares, after assuming proceeds are used to buy back shares at market price, count as dilutive.
4. Recalculate diluted EPS whenever you grant new options, your share price moves significantly, or ahead of investor updates, funding rounds or sale discussions, so there are no surprises in due diligence.