Retained earnings refer to the portion of a company’s profit that is retained or not distributed to shareholders as dividends. Instead, it is kept within the business and used for various purposes like expansion, debt repayment, and research and development.
Retained earnings are essentially the earnings that have been kept “in-house” and reinvested into the business for future growth and expansion.
The Retained Earnings Formula
The retained earnings formula is relatively simple and is calculated as follows:
Retained earnings = Beginning retained earnings + Net income (or loss) – Dividends
- Beginning retained earnings: This is the accumulated amount of earnings that the business has retained from previous periods.
- Net income (or loss): This figure represents the difference between the company’s revenue and expenses during a specific period (e.g. a fiscal year or quarter).
- Dividends: Dividends are the payments made to shareholders from the company’s profits.
For example, if a company had $10,000 in retained earnings from the previous year, generated $50,000 in net income in the current year, and paid $5,000 in dividends, the retained earnings for the current year would be:
Retained earnings = $10,000 + $50,000 – $5,000
Retained earnings = $55,000
This means that the company has retained $55,000 of its net income for future use within the business.
The Purpose of Retained Earnings
- Business Growth: Retained earnings provide an internal source of funding that can be used to facilitate business growth. These funds can be utilized for research and development, expansion, or acquisitions. By reinvesting profits back into the business, companies are able to finance new projects, research and development, and other initiatives that may lead to increased profitability in the long term.
- Financial Stability: Retained earnings provide a buffer of financial stability for businesses, allowing them to weather economic downturns or other unanticipated events.
- Dividend Payments: Retained earnings can also be used to pay dividends, which can increase shareholder value and attract new investors.
Retained Earnings FAQ
- Can a company have negative retained earnings?
Yes, a company can have negative retained earnings if it has accumulated losses over time or has had a large dividend payment.
- How do retained earnings differ from revenue?
Revenue is the total amount of money that a company generates from its operations, while retained earnings represent the portion of that revenue that is kept by the company instead of distributed to shareholders.
- What is the difference between retained earnings and profit?
Retained earnings represent the portion of earnings that a company has kept over time, while profit is the amount of revenue that exceeds expenses during a specific period.
- Are retained earnings taxable income?
Retained earnings are not subject to income tax, but when they are distributed to shareholders as dividends, those dividends are typically taxed as ordinary income.
- How do retained earnings affect financial statements?
Retained earnings are reported on a company’s balance sheet and are part of the shareholder’s equity. They are also included in the statement of changes in equity and can impact a company’s earnings per share and stock price