What Is Retained Earnings on a Balance Sheet?
When a company makes a profit they have a choice as to what should be done with the income. The way profits are handled can determine if a company profits even more. One of the things a company can do is to hold on to the profits in the form of retained earnings. Retained earnings are listed on the balance sheet under shareholders equity. If retained earnings aren't handled appropriately a company could suffer serious consequences.
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Retained Earnings
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Retained earnings are all of the profits that a company has made since it came into existence minus the dividends that have been paid out to shareholders. Retained earnings can be used to reinvest back into the business. When retained earnings are reinvested back into the business you can gauge how effective the investments are by how much a business grows and expands.
Calculation
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Calculate retained earnings by taking the beginning net earnings and adding net income and then subtracting all dividends disbursed to shareholders. Any losses incurred must be subtracted. Investors use this information to see the amount of profits re-invested into the company. The figure reported on the balance sheet is based on the day the balance sheet was formulated.
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Accumulated Deficit
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All companies do not make a profit. When times are lean a company can suffer a loss. There still needs to be an entry on the balance sheet where the retained earnings figure should go. In these situations, when retained earnings reflect a negative amount, it should be recorded as the accumulated deficit in the stockholders' equity portion of the balance sheet.
Assets/Income Generation
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In order for a company to grow, develop and expand, retained earnings have to be used for the accumulation of assets that generate income for the company. When income is generated it gives a company the means for expansion, as well as research and development. More income helps improve the financial status of a company and also makes it more favorable in the eyes of investors.
Liabilities
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Retained earnings can also be used to pay down debts and liabilities. If interest rates are high, the payments on a company's debts can increase. This shrinks profit margins and makes a company less profitable. A defense against this is paying off as much debt as possible, thereby improving the financial situation. Investors will see this as a favorable transaction because they stand to earn a return on their initial investment.
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