Retained earnings are a component of shareholder equity on a company’s balance sheet that reflects the cumulative net income of a corporation since its founding, minus any dividend payments to shareholders. The value of retained earnings can change over time depending on the amount of profits and losses incurred by a business and its corresponding investment in assets. As a result, the value of retained earnings can also differ from the value of total assets on the balance sheet. This is a function of the difference between a company’s retained earnings and its current liabilities, which are debts due within the next fiscal period.
Reported in the shareholders’ equity section of a company’s balance sheet, retained earnings are a key element to understanding a company’s book value. Book value is the amount of a company’s assets divided by its total liabilities. This helps a financial analyst determine the company’s current financial strength. In addition, retained earnings are the primary driver of a company’s future growth potential and a major factor in determining the amount of dividend payouts to shareholders.
In general, the retained earnings figure will decrease as the company incurs losses or pays out dividends to shareholders and will increase as the company records new profits. It is important to note that a company may also record negative retained earnings, which are not reported in the financial statements. This is primarily because the company does not wish to distribute these negative amounts to shareholders, and thus does not want to pay out these amounts as a loss.
The retained earnings balance is updated at the end of each accounting period as the sum of the accumulated net income of a company for that reporting period, minus the dividends paid to shareholders. This figure is then carried over to the following reporting period as the company’s retained earnings beginning balance. The net income of a company for the current reporting period will then be added to the previous year’s accumulated net income, which will create the next year’s retained earnings ending balance.
Retained earnings can be a confusing number for investors, especially when looking at the numbers on a quarterly or annual basis. The numbers can seem to fluctuate a lot from one quarter or year to another, as the company uses its retained earnings in various ways for growth purposes. The value of a company’s retained earnings can also depend on its stage of development, as growth companies will usually prefer to use their retained earnings rather than paying out dividends to shareholders.
Retained earnings differs from revenue in that the latter is a more focused measurement of a company’s performance and only reflects money that has actually been realized. The former, on the other hand, is a more holistic measure of a company’s financial health and includes all of the net income that has been recorded over a period of time. It is important to understand the distinction between these two measurements because they offer different insights into a company’s financial management, as they are located on different parts of the balance sheet.
