Retained Earnings

Term of the Day - 8 March 2024

Today’s Term is “Retained Earnings”.

"Retained earnings" represent the cumulative amount of a company's net income that is retained and reinvested in the business rather than distributed as dividends to shareholders. It is a key component of the shareholders' equity section on the balance sheet and reflects the company's ability to generate profits and its reinvestment decisions over time.

When a company earns a profit, a portion is typically distributed to shareholders as dividends, and the remaining amount is retained. Retained earnings serve as a source of internal funding for the company, allowing it to finance business operations, invest in expansion, repay debt, or engage in research and development activities.

The formula for calculating basic retained earnings is straightforward:

Beginning Retained Earnings + Net Income (or - Net Loss) - Dividends = Ending Retained Earnings.

The beginning retained earnings are carried over from the previous accounting period, and the net income (or loss) is added (or subtracted), with dividends deducted to arrive at the ending retained earnings.

Remember, this is a very basic representation, as under accounting rules, some items may be re-classified to Retained Earnings, among others.

Analyzing changes in retained earnings over time provides insights into a company's financial health, profitability, and dividend policy. Positive retained earnings indicate a profitable and growing enterprise, while negative retained earnings may suggest accumulated losses or dividend payouts exceeding profits.