Retained Earnings: The portion of net profits which are being retained by the company rather than distributed to its owners as dividends.
Retained earnings represent the net income that a company keeps after distributing dividends to its shareholders. This account in corporate finance and accounting is crucial as it is often reinvested in the business for growth opportunities or used to pay off debt. Here are some of the key elements that someone in business should know about retained earnings:
- Accumulated Profits: Retained earnings are essentially the accumulation of a company's profits over its life, minus any dividends or other distributions paid to shareholders.
- Balance Sheet Placement: Retained earnings are recorded under the shareholder's equity section of a company's balance sheet.
- Growth Indicator: High retained earnings often indicate that the company has been profitable over time and has potential growth prospects as it can reinvest these earnings.
- Negative Earnings: Negative retained earnings, or a deficit, indicate that the company has distributed more in dividends than it has earned in total income.
- Calculation: Retained Earnings can be calculated by adding net income to (or subtracting losses from) the previous term's retained earnings and then subtracting any dividends paid to shareholders.
Understanding retained earnings is crucial for any business as it provides insights into the company's capacity to sustain growth internally without relying on external financing or debt