Retained earnings are crucial to understand the business performance and health over a period. For this, every business requires the calculation of these earnings using the retained earning formula. These earnings are considered the important part of a shareholder’s equity section.

The value of retained earnings helps the organisation if they should increase the dividends or purchase the new assets with the help of increase in these types of earnings. On the other hand, the company can devise policies for improving the retained earnings.

In this blog, we will walk you through the introduction to the retained earning, what it is and why it is important for the growth of your business. Besides, we will discuss how to use the formula of retained earnings with the help of an example.

So, let’s start our discussion!

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What are Retained Earnings?

Retained earnings are represented at the end of the shareholder’s equity section on the balance sheet. Retained earnings are the earnings ‘retained’ by the company instead of paying them as dividends to the shareholders. These earnings are reserved for a long time for reinvesting back in the business.

As a result, the company has more retained earnings when a profit is earned. On the other hand, the profit decreases when the firm fails to incur any profits and suffers losses. Similarly, when they pay the increased profits as dividends, the retained earnings also go down with it.

Why Are Retained Earnings Important for Your Business?

Retained earnings reflect the actual performance of your business in terms of profits and losses. The increased earnings mean your business is doing well in increasing the profits and reinvesting the earnings into the business to buy more fixed assets or pay the liabilities of the company.

On the other hand, the lower retained earnings mean the company is paying more as dividends to the shareholders or it is performing poorly. So, it is a signal that the company should increase the retained earnings either by reducing the dividends or improving the performance of their finances.

How to Calculate RE?

Calculating retained earnings is very simple. You don’t need to struggle to get the retained earnings. Let’s find out how to calculate retained earnings with the help of a simple formula!

RE=Beginning Period +Net Income (or Loss)−Cash Dividends−Stock Dividends

The beginning period might start from the period when the company was founded. The net income means the company has earned some profit. The company might suffer a loss at the end of each period.

The cash dividends are the dividends paid to the shareholders. The retained earnings are a type of equity. This is the reason they are represented as a part of the balance sheet.

The stock dividends are given to shareholders when the company runs out of cash or has little cash. As a result, the company pays the dividends in the form of shares rather than in cash.

After subtracting the dividends from the net income or loss and the accumulated earnings, the retained earnings are left.

Retained earnings can be positive or negative. Positive earnings mean the company’s profit has increased. On the other hand, negative earnings mean the company is going down in losses or has paid more in dividends.

Example of Retained Earnings

Let’s say Company A has accumulated retained earnings of £500 000 over a period. On January 1 2022, it earned a net income of £10 000 and does not issue dividends to the shareholders.

It means to say the company’s earnings would be equal to £510 000

Retained Earnings=Beginning Period +Net Income (or Loss)−Cash Dividends−Stock Dividends

= £500 000 + £10 000 + 0 +0

= £510 000

So, we can say that the company earned £10 000 in profits and retained all of them. The company can use this accumulated earnings of £510 000 to buy assets or pay the debt obligations or other liabilities.

Conclusion

In sum, retained earnings are important for the growth and expansion of a company. If a company wants to expand its business, it can retain all the earnings and use them to pay for the liabilities or increase the fixed assets.

On the other hand, a company can use these earnings to increase the dividends of the shareholders. Positive or negative earnings points towards the overall performance of a company and they can decide on the future expansion of the fixed assets or the dividends ultimately.

Similarly, the retained earnings formula is easier to calculate. It helps you understand how much the company has earned over the past few years in retained earnings. It is stated at the end of the balance sheet of the shareholder’s equity section.

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Disclaimer: All the information provided in this article of Retained Earnings Formula is general in nature. It does not intend to disregard any of the professional advice.