Retained earnings represent the accumulated net profits or losses of a company over time that have not been distributed as dividends to shareholders. It’s a component of the shareholders’ equity on the balance sheet and reflects the company’s ability to reinvest its profits for future growth.
The formula for retained earnings is quite straightforward:
Retained Earnings=Beginning Retained Earnings+Net Income (or Loss)−DividendsRetained Earnings=Beginning Retained Earnings+Net Income (or Loss)−Dividends
Here’s what each component means:
- Beginning Retained Earnings: The retained earnings from the previous accounting period. It serves as the starting point for the current period.
- Net Income (or Loss): The company’s total earnings or losses during the current accounting period. This includes revenues, expenses, taxes, and other income.
- Dividends: The amount of profits distributed to shareholders. If the company pays dividends, this amount is subtracted from the net income.
The resulting figure represents the retained earnings at the end of the current accounting period. This value is carried over to the next accounting period as the beginning retained earnings.
Retained earnings are important because they indicate how much of the company’s profits are being reinvested in the business rather than distributed to shareholders. High retained earnings can signal financial stability and the ability to fund future growth, while low or negative retained earnings might indicate financial challenges or heavy dividend payouts.