Retained earnings are the money that a company keeps from its profits. The company does not give this money to its shareholders as dividends. Instead, the company uses this money to grow its business or pay its debts. Therefore, retained earnings show how much money a company has made over time and how well it uses its money to create value.
Why Retained Earnings Are Important
In addition, retained earnings tell you a lot about a company’s financial health and performance. The company has invested some of its profits in its growth and expansion. It has also given back some of its profits to its shareholders as dividends. A positive retained earnings balance means that the company has made more profits than losses or dividends. On the other hand, a negative retained earnings balance means that the company has made more losses than profits or dividends.
How to Calculate Retained Earnings
You can use this formula to calculate retained earnings:
Retained Earnings = Retained Earnings at the Start + Profits – Dividends
The beginning of the period is usually the start of a year or a quarter. Retained earnings at the start are the retained earnings balance at that time. Profits are the amount of money that the company made or lost during the period, which you can find on the income statement. Dividends are the payments that the company made to its shareholders during the period, which can be cash dividends or stock dividends.
For example, suppose a company had a retained earnings balance of $10,000 at the start of the year. During the year, it made a profit of $5,000 and paid out $2,000 in cash dividends and $1,000 in stock dividends. The retained earnings balance at the end of the year would be:
Retained Earnings = $10,000 + $5,000 – $2,000 – $1,000 Retained Earnings = $12,000
This means that the company increased its retained earnings by $2,000 during the year.
How to Report Retained Earnings
You can find retained earnings on the balance sheet under the shareholders’ Equity section. You can also find them on a separate statement called the statement of retained earnings, which shows how retained earnings changed during the period. The statement of retained earnings usually includes this information:
- Retained earnings balance at the start
- Profits or losses for the period
- Dividends paid for the period
- Retained earnings balance at the end
The statement of retained earnings helps you understand how the company’s retained earnings changed during the period and how they are connected to the income statement and the balance sheet.
Summary
- Retained earnings are the money that a company keeps from its profits. The company does not give this money to its shareholders as dividends. Instead, the company uses this money to grow its business or pay its debts.
- Retained earnings show how much money a company has made over time and how well it uses its money to create value.
- You can use this formula to calculate retained earnings: Retained Earnings = Retained Earnings at the Start + Profits – Dividends
- You can find retained earnings on the balance sheet under the shareholders’ equity section and on a separate statement called the statement of retained earnings.
