What is Earning Power?

Earning power is the proven ability of an individual, company, or security to generate earnings or profits over time, assuming conditions are optimal. While there are various ways to calculate the exact range of earning strength, many methods involve considering the total assets of the entity, including any growth or loss that has taken place from one accounting period to the next. The general concept of earning power is helpful in creating and refining a sound financial strategy for households as well as for multinational corporations.

For individuals, earning power is often determined by the amount of income that the individual has demonstrated the ability to produce in a given period, usually monthly or annually. The core factor of this type of calculation is based on the salary or wages earned through a full-time job. In situations where individuals develop secondary income streams, those earnings are also considered to be part of the overall income-producing effort for the period. There is some difference of opinion as to whether individuals should calculate this figure based on gross or net income. However, as long as the method is consistent, either figure will suffice.

Companies also benefit from accurately determining their current earning power. In some instances, this figure is based on the earnings before paying interest and taxes, a figure sometimes referred to as EBIT. Other companies may choose to base their earning power more on the yield on securities, such as the dividend yield on the stocks issued by the company. A relatively new company may choose to determine the strength of its earning ability by looking closely at the return on assets, like invested capital, used to establish the operation of the new business.

The idea of earning power is also associated with investments. An investor will want to look closely at the ability of a given security to generate revenue, assuming that market conditions are at their most favorable. Accurately projecting the earning potential of investments helps to increase the chances of a significant yield on securities, while minimizing the possibility of incurring losses.

It is important to note that any calculation of earning power is based on the assumption that optimal conditions exist. Should conditions change, there will be a need to calculate earning ability again. For example, if an individual sustains injuries that prevent him or her from continuing with current employment, earning expectations are adjusted to address the new circumstances. Assuming the individual is still capable of performing some other type of work, that new income stream can form the basis for arriving at a new assessment of earning power.