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Retained Earnings

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Key Highlights

  • Retained earnings are the total profits a company has kept over time, after sharing some of those profits with shareholders as dividends.

  • To calculate retained earnings, you start with the amount from the beginning of the period, add the net income (or subtract the net loss) earned during that period, and then subtract any dividends paid to shareholders.

What Are Retained Earnings?

Retained earnings are the total profits a company has kept over time, after sharing some of those profits with shareholders as dividends. These earnings are kept within the business and can be used for reinvestment, funding growth, paying off debt, or meeting future obligations, rather than being distributed as dividends

Key Features

  • Part of Shareholders’ Equity: Retained earnings are reported on the balance sheet under shareholders’ equity and accumulate year after year.

  • Indicator of Financial Health: They show how much profit the company has saved over time, reflecting its ability to reinvest and grow.

  • Flexible Usage: Companies may use retained earnings to expand operations, invest in research and development, purchase new assets, buy back shares, or issue bonus shares to shareholders.

  • Management Decision: The decision to retain earnings or distribute them as dividends is typically made by company management based on the business’s strategic needs and shareholder expectations

How Are They Calculated?

To calculate retained earnings, you start with the amount from the beginning of the period, add the net income (or subtract the net loss) earned during that period, and then subtract any dividends paid to shareholders.

Why Do Retained Earnings Matter?

  • Fuel for Growth: Companies use these funds to invest in new projects, like opening stores, developing products, or upgrading tech.

  • Financial Health Check: Growing retained earnings often mean a company is profitable and stable. On the flip side, negative retained earnings might hint at losses or heavy reinvestment (common in startups).

  • Flexibility: The money can be used to pay off debt, buy back shares, or even issue bonus shares to keep shareholders happy without dipping into cash reserves.