Retained earnings: What do they mean?

Retained earnings are a crucial component of a company's financial statements. They represent the accumulated profits a business has left over after distributing any dividends to shareholders.

Why are retained earnings calculated?

Retained earnings refer to the portion of a company's net income or profits they keep or retain after meeting any dividend payout responsibilities. Those cumulative retained earnings are reinvested back into the company, as part of its overall equity.

Be a financially smart family!

Be a financially smart family!

From saving for the future to understanding credit, see how families are thriving with Greenlight.

Try Greenlight today

How is it calculated?

Retained earnings are calculated by subtracting dividends paid to shareholders from the company's net income. It can also be affected by any losses incurred by the company.

Formula:

Retained Earnings = Beginning Retained Earnings + Net Income - Dividends

1. Beginning Retained Earnings: The total retained earnings balance from the end of the prior accounting period.

2. Net income: The total net profit or loss in your current accounting period.

3. Dividends: The cash or stock dividends or returns your company has paid out to stockholders from the current accounting period. 

Importance for shareholders

Retained earnings directly impact overall shareholder equity, which is the value of the company's assets minus its liabilities. When retained earnings increase, shareholder equity also increases, indicating a stronger financial position for the company.

As part of a company’s equity, retained earnings can be used to reinvest in the company. For example, you might use a portion of retained earnings to fund future growth and expansion projects, potentially leading to increased profits and dividends for shareholders in the long run. Or, you might use it to pay down debt. 

Importance for the company

Retained earnings are essential for a company's financial stability and growth. It allows the company to have funds available for investments, research and development, or unexpected expenses without relying on external funding sources. By retaining earnings, a company can also demonstrate financial strength and stability to investors and creditors.

Factors affecting retained earnings

Several factors can affect a company's retained earnings, such as:

• Dividend payments: The more dividends paid out to shareholders, the lower the retained earnings.

• Net income: If a company experiences higher profits, there may be a larger amount of retained earnings.

• Business decisions: A company's management may choose to use retained earnings for various purposes, such as paying off debts or expanding operations, which can impact the overall amount of retained earnings.

Retained earnings serve as an indicator of a company’s profitability, stability, and potential for future growth. By analyzing a company's retained earnings, shareholders can make informed decisions about their investments and companies can strategize for long-term success. But, retained earnings are not the only indicator of a company's financial health; they’re a part of the whole picture along with many other factors including debt levels, cash flow, and market trends.