Overview of Retained Earnings

Definition of
Retained Earnings

What are Retained Earnings? Retained Earnings represent the cumulative amount of a company's net income (or net profit) that has been kept or "retained" in the business over time, rather than being paid out to shareholders as dividends. It's the portion of profits that are reinvested back into the company for purposes like funding growth, paying down debt, or financing other business activities. Retained Earnings are reported in the equity section of a company's Balance Sheet.

Activities Related to
Retained Earnings

Here is a list of Retained Earnings related activities: Calculating Net Income or net loss for an accounting period (from the Income Statement), Determining the amount of dividends declared and paid to shareholders, Updating the Retained Earnings balance using the formula: Beginning Retained Earnings + Net Income (or - Net Loss) - Dividends = Ending Retained Earnings, Reporting the ending Retained Earnings balance on the Balance Sheet, and Making strategic decisions about profit reinvestment versus dividend distribution.

The Importance of
Retained Earnings

Retained Earnings are important because they represent a key source of internal financing for a company's growth and expansion planning. A healthy and growing retained earnings balance indicates that a company has been consistently profitable and has chosen to reinvest those profits back into the business, which can fund new projects, research and development, acquisitions, or debt reduction without needing to raise external capital. For investors, a strong retained earnings history can signal a company's ability to generate sustainable profits and its potential for future growth. It is a critical component of Shareholder Equity.

Key Aspects of
Retained Earnings

Accumulated Profits
Represents the total net earnings a company has accumulated over its lifetime, less any dividends paid.

Equity Account
A component of the shareholders' equity section on the Balance Sheet.

Source of Internal Financing
Funds that are reinvested in the business to support growth, operations, or reduce debt.

Impacted by Net Income/Loss and Dividends
Increases with net income and decreases with net losses and dividend payments.

Concepts Related to
Retained Earnings

Retained Earnings are directly linked to Net Income (from the Income Statement) and Dividends paid to shareholders. They are a critical part of Shareholder Equity, as shown on the Balance Sheet. A Statement of Retained Earnings details the changes in this account over a period. Understanding profit distribution policies is key to analyzing retained earnings.