Definition
Retained earnings refer to the portion of net income that a company keeps or ‘retains’ after it has paid out dividends to its shareholders. Essentially, it’s the cumulative total of profits that have been reinvested in the business rather than distributed. This fund is used for reinvestment in the business or to pay debt.
Phonetic
The phonetic pronunciation of “Retained Earnings” would be: rɪˈteɪnd ˈɜːrnɪŋz.
Key Takeaways
- Retained Earnings are the net income that a company retains (does not distribute to shareholders in the form of dividends) to reinvest in the business or pay off debt. It offers an insight into a company’s financial health and growth potential.
- A positive amount of Retained Earnings indicates that the company has been generating profits over time, while a negative balance, often called an accumulated deficit, suggests the company has accumulated more losses than profits.
- Finally, Retained Earnings are reported in the shareholders’ equity section of the company’s balance sheet. The change in retained earnings is usually reported in the statement of retained earnings, if not included in the income statement or a combined statement of comprehensive income.
Importance
Retained earnings are a critical measure of a company’s financial health and potential for growth, constituting the net amount of a company’s profits that are kept or retained after it has paid out dividends to its shareholders. This capital can be used to invest back into the company for things like product development, equipment upgrade, debt reduction or to boost liquidity. It reflects a business’s ability to generate positive earnings over time, providing a clear insight into a company’s profitability trend. Moreover, investors and lenders often scrutinize retained earnings as it’s a strong indicator of management’s long-term business strategy and financial planning, hence deciding the intrinsic value and credibility of the organization.
Explanation
Retained earnings refer to the portion of business profits that are reinvested in the company rather than being distributed as dividends to shareholders. The purpose of retained earnings is to enhance the financial strength of the company and to fund its future expansion and growth. By reinvesting the profits, the company can improve its operations, develop new products, conduct research and development, purchase new assets, repay debts, or save for future uncertainties. Therefore, retained earnings serve as an internally generated source of financing for a company.Retained earnings are not just about reinvesting the profits but are also representative of the company’s long-term economic value creation. Investors often look to a company’s retained earnings, among other financial indicators, to assess the firm’s financial health and growth prospects. It indicates the company’s ability to generate profits over time, which can directly impact its market capitalization and stock price. Thus retained earnings contribute to the overall wealth of the company’s shareholders, albeit not in the form of direct dividends, but through potential increases in share price.
Examples
1. Apple Inc.: Known as one of the world’s most profitable and valuable companies, Apple has a significant amount of retained earnings. As of their 2020 financial year-end, Apple reported a balance of retained earnings over $14,821 billion, which is the net amount of the company’s profits reinvested in the business since its inception after paying out dividends.2. Walmart Inc.: The multinational retail corporation, Walmart, is another example. Walmart reported retained earnings of $79,634 million in the fiscal year ending 2020. These earnings have been accumulated over the years and are used to reinvest in their operations, further expansion, and pay-down of debt.3. Google Inc. (Alphabet): Technology giant Alphabet (Google’s parent company), as of the end of 2020, reported retained earnings over $139,520 million. Google uses these earnings to finance their R&D projects and innovations, as well as other investments and acquisitions, thereby continuing their industry expansion and influence.
Frequently Asked Questions(FAQ)
What are retained earnings?
Retained earnings are the portion of a company’s net income that is not paid out as dividends to shareholders. Instead, it is retained by the company for reinvestment back into the business or to pay off debt.
Where can I find information about a company’s retained earnings?
Information about a company’s retained earnings is generally located in the equity section of a company’s balance sheet.
How are retained earnings calculated?
Retained earnings are calculated by adding net income to (or subtracting any net losses from) previous retained earnings and subtracting any dividends paid out to shareholders. The formula is: Retained Earnings = Previous Retained Earnings + Net Income – Dividends Paid.
Why are retained earnings important?
Retained earnings show a company’s cumulative net earnings or profit after accounting for dividends. It reflects how much money the company can reinvest in the business, pay off debts, or pay out to shareholders. Positive retained earnings indicate a profitable company, whereas negative retained earnings suggest cumulative losses.
Can a company have negative retained earnings?
Yes, if a company has more net losses than it has profits or pays out more in dividends than it is holding as net income, it will have negative retained earnings.
What does it mean if a company’s retained earnings increase?
An increase in retained earnings typically indicates that the company is profitable, and has a reserve of money that it can use for future growth investments or to pay dividends to shareholders.
How do retained earnings affect a company’s balance sheet?
Retained earnings are part of the owner’s equity section of a company’s balance sheet. They help to paint a picture of the company’s financial health and are an indicator of the long-term growth potential of the business.
Related Finance Terms
- Net Income
- Dividends
- Balance Sheet
- Shareholder Equity
- Profit Reinvestment
Sources for More Information
