Retained earnings statement is an important document for a company, as it helps in analysis and proper management of its earnings. In this article, we have explained its use and also provided the calculation method.
Retained earning statement, or the statement of retained earnings, is a statement of the net earnings that are not paid to the shareholders and are invested back into the business or used to pay off debt. In an accounting cycle, this is the second financial statement and is prepared after the income tax statement. It basically provides the company an idea about the difference in the earnings over varying periods of time. Let us first try to understand the concept behind this.
Whether a company is making profits or losing money is determined by analyzing its income and expenses. The amount of money spent on operational activities, production, salaries, depreciation, etc., are categorized as expenses. The excess of income over the expenses for a given period is referred to as ‘earnings’. If a company is making profits, some of it is shared with the shareholders as dividend, while the rest is retained for further expansion, acquisitions, investments, etc. These earnings are not fixed over a period of time, so they are recorded on a statement in accordance with the U.S. Generally Accepted Accounting Principles (GAAP).
Calculation
The formula to calculate retained earnings is quite simple. You just need to be aware about some of the terms used in accounting and economics, and you can easily calculate this statistic. The formula is:
Retained Earnings (RE) = Previous Retained Earnings + Net Income – Dividend
On the basis of this formula, if a company has previous retained earnings of USD 100,000 and has made a profit of USD 125,000 after all taxes and deductions, out of which USD 20,000 has to be paid as dividend, then the retained earnings would be:
Retained earning = {100,000 + 125,000 – 20,000} = USD 205,000
Sample
| ABC Private Limited | |
| Statement of Retained Earnings for the Year ending December 31, 2010 |
|
| Balance of the Retained Earnings on December 31, 2009 | USD 100,000 |
| (+)Net income in year 2010 | USD 125,000 |
| (-)Dividends to stockholders | (-)USD 20,000 |
| Retained Earnings for 2010 | USD 205,000 |
Application
The legendary investor Warren Buffet has laid emphasis on retained earnings and called them a sign of good financial management. An organization that intends to grow must know how to reinvest its income back into the business. Also, there are times when the company is not able to make as much profits as planned, in such times, retained earnings ensure that the operations are not hampered and there is no need to take desperate measures like layoffs, closures, etc. Most companies carry a certain amount of debt on their books; the retained surplus also helps to pay back this debt. This statement makes the business evaluate its plans and prioritize the use of these earnings accordingly. For example, if a company is thinking about expansion, but also has some debts to pay, a careful preparation and analysis of this statement helps it prioritize as to which is more important for the business.