EPS and Cash Flow Information in Assessing Performance and Liquidity

Two figures dominate the headlines about a company: its earnings per share and its profit. Both are useful and both can mislead. Earnings per share is the shareholders’ slice of the profit, and the market watches it closely; but it is built on accounting policies, it can be changed by capital transactions that do not alter the business, and it says nothing about cash.

The statement of cash flows answers the question that profit cannot: did the business actually generate the cash to pay its debts, invest and reward its owners?

This topic covers earnings per share as a performance measure and what the market does with it, the limitations of the measure, the relationship between profit and cash, the ratios drawn from the statement of cash flows, free cash flow, and how to read the statement for liquidity and going concern, using the Zaria Plc figures from the previous topics. The next topic covers the limitations of financial analysis.

Both parts are examined. In May Diet, 2026, Question 3(c) (8 marks) asked for four limitations each of earnings per share and return on capital employed as tools of analysis, and November Diet, 2025, Question 3 included the interpretation of cash flow information. Read interpreting performance and writing the analysis report first.

Earnings per share as a performance measure

Earnings per share (EPS) is the profit attributable to ordinary shareholders divided by the weighted average number of ordinary shares. It is used to assess a company’s performance in the capital market:

• Trend. A steady rise in EPS suggests growing profitability. EPS is more informative as a trend over years than as a single figure, and the growth should be compared with inflation and with other companies.
• Price-earnings ratio. The share price divided by EPS is the market’s verdict on the earnings; it is the basis of many valuations.
• Earnings announcements. When a company announces its results, the share price tends to move if the earnings differ from what the market expected. The reaction is to the unexpected part of the earnings: results that are in line with expectations change the price little. This is why analysts forecast EPS, and why companies are tempted to manage it. The size and direction of the market’s reaction also depend on the quality of the earnings, that is, whether they are backed by cash and likely to be repeated.

Zaria’s EPS rose from 49.0 kobo to 52.5 kobo, an increase of 7.1%, against sales growth of 20%. The market price of ₦6.30 gives a price-earnings ratio of 12.

Limitations of EPS

• Accounting policies. Not all entities use the same policies, so the EPS of different entities may not be comparable, and a change of policy changes the EPS.
• Inflation. EPS does not allow for inflation, so growth over time may reflect only higher prices. This matters in an economy with high inflation.
• It ignores cash flows. EPS measures profit, which is only part of performance. A company with growing EPS can still have a shortage of cash.
• Changes in capital. A bonus issue, rights issue or share split changes the number of shares without changing the business, so previous EPS must be restated to compare. A fall in EPS after new equity may be dilution and not a fall in profit. For example, earnings of ₦100m on 200 million shares (50 kobo) are followed by earnings of ₦120m after a one-for-four bonus issue, giving 250 million shares.
  EPS is ₦120m ÷ 250m = 48 kobo, but the previous year restated is ₦100m ÷ 250m = 40 kobo, so EPS has grown by 20%, not fallen by 4%.
• Manipulation. Earnings can be managed by choice of policies and estimates, and by timing.
• Risk and capital employed. EPS says nothing about how much capital was used to earn it or how risky the business is.
• Dilution. Basic EPS ignores potential shares from convertibles and options; diluted EPS shows their effect.

Cash flow information

The statement of cash flows complements the statement of profit or loss. Profit is measured on the accruals basis and depends on policies and estimates, while cash flows are facts. Cash-based measures are less affected by differences in accounting policies, so comparisons between entities are easier, and they show liquidity, solvency and the ability to adapt to changing circumstances.

A company that is profitable on paper but short of cash can fail, so the statement is central to the assessment of going concern.

Reading the statement

• Operating activities: do the operations generate cash, and how does it compare with profit? A sustained gap between profit and operating cash flow needs an explanation (rising receivables, inventory, aggressive revenue recognition).
• Investing activities: is the company investing to grow (capital expenditure above depreciation) or running down its assets, or selling assets to raise cash?
• Financing activities: how are the investments funded: from operating cash, new debt or new equity? Are dividends covered by the cash generated?

A healthy mature business generates cash from operations, finances its own investment and pays dividends. A growing business may spend more than it generates and rely on external finance. A business that repays loans and pays dividends from the sale of assets is not sustainable.

Cash-based ratios

• Cash conversion = cash generated from operations ÷ profit before interest and tax.
• Free cash flow = net cash from operating activities − capital expenditure. Cash left (or needed) after maintaining and expanding the asset base.
• Capital expenditure cover = cash generated from operations ÷ capital expenditure.
• Cash interest cover = cash generated from operations ÷ interest paid, and cash dividend cover = net cash from operating activities ÷ dividends paid.

Zaria Plc: profit and cash

Zaria’s Year 2 depreciation was ₦70m. Its statement of cash flows can be derived from the two statements of financial position. Profit before interest and tax ₦180m plus depreciation ₦70m is ₦250m. Working capital took cash: receivables −₦60m, inventory −₦40m, payables +₦50m, a net −₦50m, so cash generated from operations is ₦200m.

Interest paid was ₦30m and tax paid ₦38m (opening payable ₦33m + charge ₦45m − closing ₦40m), so net cash from operating activities is ₦132m. Capital expenditure was ₦210m (non-current assets ₦760m + purchases − depreciation ₦70m = ₦900m). Financing brought in a net ₦38m: new loans ₦80m less dividends ₦42m. The net movement is ₦132m − ₦210m + ₦38m = −₦40m, taking cash from ₦90m to ₦50m.

Profit rose and the dividend is well covered by operating cash, but Zaria spent more than it generated, funding the difference from a new loan and its cash balance. This is a pattern of growth, not of trouble, but the cash balance cannot fall much further.

The ideas in more depth

Why cash and profit differ

Profit includes sales not yet collected, depreciation that is not a cash cost, and excludes capital expenditure and loan movements. Every difference has a cause that can be traced in the statements, and the tracing is the analysis.

Why the market reacts to surprises

Prices already reflect what investors expect. An announcement that matches expectations adds nothing; one that is better or worse changes the expectation and so the price. That is why the same profit may be good news for one company and bad news for another.

Sources and references

• International Accounting Standard (IAS) 33 Earnings per Share and IAS 7 Statement of Cash Flows; the ratios are conventional analytical measures.

These points are stated as at 5 November 2026.

Worked examples

1. Shares.
   200m + 50m = 250m.
2. EPS. This year 48 kobo; last year restated 40 kobo; growth 20%.

1. Free cash flow.
   132 − 210 = −₦78m.
2. Meaning. The business invested more than it generated and needed external finance or its cash balance.

1. Conversion.
   200 ÷ 180 = 111%, because depreciation is added back and working capital took ₦50m.

How to answer in the exam

• For limitations questions, give each limitation with a short explanation and an example.
• Restate EPS when there has been a bonus or rights issue.
• For cash flow questions, comment on each of the three sections and on the link to profit.
• Conclude on liquidity and going concern, and on how investment was funded.

Common mistakes in the exam

• Comparing EPS across years without restating for a bonus issue.
• Treating a fall in EPS after a share issue as a fall in profit.
• Listing limitations without explanation.
• Ignoring the cash flow statement in a liquidity question.
• Concluding that high profit means high cash.
• Confusing free cash flow with net cash from operating activities.

Quick revision

• EPS limits: policies, inflation, ignores cash, capital changes, manipulation, risk, dilution.
• Markets react to earnings surprises; quality of earnings means cash backing.
• Free cash flow = net cash from operating activities − capital expenditure.
• Compare profit with cash; read operating, investing and financing sections together.

Practice questions

These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.

Recall check: multiple choice

Section B style: written questions

A further written question

Model answers

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