Earning power refers to how well a business can perform financially. Having earning power involves adhering to prescribed accounting habits while making good profit at the same time. Also, earning power can only be recognized if such profits are generated on top of the ability to fulfill all of the company’s financial obligations. This includes proper payment of wages and maintenance of its infrastructure and other assets.
By being able to prove its ability to maintain its earning power, a business is able to place itself in a good position with financial institutions. Many times, companies find that even if they have sufficient assets to cover the purchase of additional assets, they can profit much more by loaning the necessary amount from banks. This practice is known as leveraging. For companies to be able to address their leveraging needs and get the best loan deals, they should show themselves to be financially stable and therefore capable of repaying their loans when they are due. One of the best way to show this is to demonstrate earning power.
Showing earning power does not only send a positive signal to banks, but it also serves to encourage investors. Prospective investors are more likely to be encouraged to buy shares from a company which is able to show that it can sustain consistent profits over a long period of time.
Companies and financial institutions may use a variety of methods in order to gauge earning power. The choice of method really depends on the specific information required, such as the company’s attitude towards reinvestment, or how much profit it is capable of making within a given period of time.
