What Are Retained Earnings?

Whether you are a founder, an investor, or an accountant, retained earnings are an important concept to know and understand.

Retained earnings refer to the amount of net income remaining after a company has paid out dividends to its shareholders.

Stockholders, especially those who have been with the company for a long time, may expect to be financially rewarded when the company they invested in is doing well. This reward is usually given out in the form of dividends or portions of a company’s earnings.

Retained earnings refer to the portion of a company’s earnings after these dividends have been paid out. This is money that can then be reinvested back into the company to help the business grow, whether that is by expanding budgets, increasing production capacity, hiring more employees, buying out competition firms, or launching new products.

Retained Earnings vs. Revenue vs. Profit

Retained earnings, revenue, and profit are all similar ideas, but it is important to know the distinctions between them.

Revenue is the money that is gained by selling a product or providing a service. Revenue does not take into account the costs of operating a business, nor the cost of providing shareholders with dividends.

Profit, also sometimes called net income, is revenue minus the cost of providing that service or product. By calculating profit, you are able to see how much net revenue you have earned. This number can sometimes be negative if your costs have outweighed your revenue.

As we stated before, retained earnings are how much money is left over from your profits after paying out dividends to your shareholders.

Though these three are similar, the math behind them makes them very different.

How to Calculate Retained Earnings

To calculate retained earnings, you will need to know a few things.

First, you need to know your net income or net losses. This is how much money is left over when subtracting costs from revenue. If the result is positive, it is net income. If the result is negative, it is net losses.

Second, you need to know the amount of money paid out to shareholders in the form of dividends. Dividends can be paid out in cash or in stock.

Finally, you will need to know the retained earnings of the previous period. That is, how much money is leftover from the retained earnings of the previous quarter or previous fiscal year.

Retained earnings are calculated with the following formula:

The number you are left with tells you how much money you can invest back into the company.

Example of Retained Earnings Calculations

Here is another example:

What Is a Statement of Retained Earnings?

A statement of retained earnings is a document prepared by companies that details how much of their net income is going back into the company rather than into the pockets of shareholders.

This can be an important document, especially if you are considering buying stock in a certain company, as it reveals important information about the kind of dividends you can expect and how much the company is investing in new growth.

How to Interpret Results of Retained Earnings Calculations

Having a high amount of retained earnings can be a good sign that the company has the potential to grow and increase its stock value. A company with high retained earnings can use those earnings to grow into new markets, increase productivity, pay off debts, and otherwise increase its profitability.

If a company has high retained earnings and is properly investing those earnings into growing, you can expect their stock value to increase. If a company has high retained earnings, but its stock value is not increasing, it may be a sign that the company is poorly investing its retained earnings.

Why Do Managers and Stakeholders Like to Retain Earnings?

Managers like to retain earnings because it allows them to reinvest money in the company and then allocate funds to where they are needed.

For example, a manager would know when machinery may need to be replaced, when there ought to be an expansion in the sales team, and when a budget expansion may lead to more profits down the road.

Managers would know best where to invest back into the company in order to increase profits.

Stakeholders like to retain earnings for similar reasons. While it may seem counterintuitive, stakeholders also benefit from investing money into the company, even if it would go directly to them.

As the company has increased success and wider profit margins, the stock value of the company goes up. This would increase the value of the stock stakeholders have, which they can then choose to sell.

In this way, they may receive more value from their stock than they would if they had received dividends.

Author

Chris Kolmar

Chris Kolmar is a co-founder of Zippia and the editor-in-chief of the Zippia career advice blog. He has hired over 50 people in his career, been hired five times, and wants to help you land your next job. His research has been featured on the New York Times, Thrillist, VOX, The Atlantic, and a host of local news. More recently, he's been quoted on USA Today, BusinessInsider, and CNBC.