Retained Earnings are the portion of a company’s cumulative net income that remains after paying out dividends to shareholders. They accumulate over time on the balance sheet within shareholders’ equity.
Why are Retained Earnings Important?
Retained Earnings are important because they:
Fund Growth: Provide internal capital for reinvestment in operations, research, acquisitions, and capital expenditures.
Signal Financial Health: A growing retained earnings balance indicates consistent profitability and prudent dividend policy.
Reduce Reliance on External Financing: Use of retained earnings can lower the need for debt or equity issuance, minimizing financing costs and dilution.
How are Retained Earnings Calculated?
Retained Earnings are calculated as:
Ending Retained Earnings = Beginning Retained Earnings + Net Income (or − Net Loss) − Dividends Paid
Where:
Beginning Retained Earnings is last period’s ending balance.
Net Income is the profit earned during the period.
Dividends Paid are cash or stock distributions to shareholders.
Additional Considerations
Dividend Policy Impact: Companies balance dividend payouts and retained earnings to satisfy investors and support strategic plans.