Shareholders Equity Vs. Retained Earning

A company’s executives may want to forget a bad operating period , such as a quarter or fiscal year, and wash their hands of the whole thing. However, the retained earnings master account is there to remind them of past mistakes and the ensuing operating demise. Investors and business partners, such as vendors and customers, heed retained earnings and shareholders’ equity to gauge the corporate financial standing.

Retained Earnings

When a company publishes profits, the positive development brings positive press to top management and department heads, but it rivets new attention on a pastiche of financial accounts. These include revenues, expenses, gains and losses -- all of which lead to net income or loss, which later makes it into retained earnings. Also known as accumulated profits, retained earnings represent income a business has kept in its coffers since its inception. Other similar phrases for retained earnings include “income reserve,” “undistributed profits” and “retained income.” Revenues and gains increase retained earnings, unlike losses and operating expenses.

Shareholders’ Equity

In the corporate context, senior executives don’t rest until they nail a winning formula for profitability, liquidity and operational efficiency. In taking tangible steps to improve the organization’s financial standing, department heads spearhead fundraising events, such as the issuance of common stock and preferred shares. The last two items are integral to a shareholders’ equity statement, similar to dividends, treasury stock and retained earnings. A shareholder is a company or person who pours money into an entity’s activity, whether it be on a public platform or through a private sale. Public platforms, or securities exchanges, include the New York Stock Exchange and the London Stock Exchange. “Treasury stock” is interchangeable with “repurchased shares.”

Interrelation

While shareholders’ equity is distinct from retained earnings, both items are conceptually close. Accumulated profits are integral to a statement of changes in shareholders’ equity, which displays all corporate equity items. Retained earnings increase an organization’s equity because it’s money the business can use to operate, make cash and settle financial commitments.

Significance

When raising and making money prove difficult in the global marketplace, a company’s top brass looks for ways to shore up the corporate balance sheet. This is the other report displaying shareholders’ equity and retained earnings, in addition to assets and liabilities. In financial terminology, shoring up a balance sheet means finding sound ways to purchase strategic assets, borrow at affordable rates, lower indebtedness over time and run an efficient, profitable operation. A balance sheet also goes by the names “statement of financial position” and “report on financial condition.”

References

• Wiley: Chapter 16 -- Stockholders’ Equity - Retained Earnings
• Real Life Accounting; Theme: Understanding Equity Accounts; John W. Day
• Principles of Accounting; Corporate Equity Accounting; Larry Walther
• University of Northern Iowa John Pappajohn Entrepreneurial Center: Statement of Changes in Shareholders’ Equity Basics