What Are Retained Earnings?

Retained earnings are the cumulative net earnings or profits a company keeps after paying dividends to shareholders. Dividends are the last financial obligations paid by a company during a period. “Retained” refers to the fact that those earnings were kept by the company.

Retained Earnings Formula and Calculation

$\begin{aligned} &\text{RE} = \text{BP} + \text{Net Income (or Loss)} - \text{C} - \text{S} \\ &\textbf{where:}\\ &\text{BP} = \text{Beginning Period RE} \\ &\text{C} = \text{Cash dividends} \\ &\text{S} = \text{Stock dividends} \\ \end{aligned}$​RE=BP+Net Income (or Loss)−C−Swhere:BP=Beginning Period REC=Cash dividendsS=Stock dividends​

What Can Retained Earnings Tell You?

Retained earnings refer to the historical profits earned by a company, minus any dividends it paid in the past. To geꦜt a better unde🌼rstanding of what retained earnings can tell you, the following options broadly cover all possible uses that a company can make of its surplus money. For instance, the first option leads to the earnings money going out of the books and accounts of the business forever because dividend payments are irreversible.

All of the other options retain the earnings for use witඣhin the business, and such investments and funding activities constitute retained🌼 earnings.

• The income money can be distributed (fully or partially) among the business owners (shareholders) in the form of 澳洲幸运5官方开奖结果体彩网:dividends.
• It can be invested to expand existing business operations, like increasing the production capacity of the existing products or hiring more sales representatives.
• It can be invested to launch a new product/variant, like a refrigerator maker foraying into producing air conditioners or a chocolate cookie manufacturer launching orange- or pineapple-flavored variants.
• The money can be used for any possible merger, 澳洲幸运5官方开奖结果体彩网:acquisition, or partnership that leads to improved business prospects.
• It can be used for 澳洲幸运5官方开奖结果体彩网:share buybacks.
• The earnings can be used to repay any long-term outstanding loans (debt) that the business may have.

Retained earnings are also called earnings surplus and represent reserve money, which is available to company management for reinvesting back into the business. When expressed as a percentage of total earnings, it is also called the 澳洲幸运5官方开奖结果体彩网:retention ratio and is equal to:

1 - the 澳洲幸运5官方开奖结果体彩网:Dividend Payout Ratio

Although the last optioꦆn of debt repayment also results in money flowing out of the bu▨siness, it still has an impact on the business’s accounts (for example, saving it for future interest payments, which qualifies it for inclusion in retained earnings).

Management and Retained Earnings

The decision to retain earnings or to distribute them among shareholders is usually left to the company management. Howeve꧋r, it can be challenged by the shareholders through a majority vote, as they are the actual owners of ⭕the company.

Management and shareholders may want the company to retain earnings for several different reasons. Being better informed about the market and the comꦅpany’s business, the management may have a high-growth project in view, which they may perceive as a candidate for generating substantial returns in the future.

In the long ⛦run, such initiatives may lead to better returns for compa🌃ny shareholders, rather than those gained from dividend payouts. Paying off high-interest debt also may be preferred by both management and shareholders, instead of dividend payments.

On the other hand, when a ൲company generates surplus income, a portion of the long-term shareholders may expect some regular income in the form of dividends as a 🥂reward for putting their money into the company. Traders who look for short-term gains may also prefer dividend payments that offer instant gains.

Most often, the company’s management takes a balanced approach. It involves paying out a nominal amount of dividends and retaining a good🧸 portion of the earnings, which offers a win-win.

༺Wha💃t Is the Difference Between Retained Earnings and Dividends?

Dividends can be distributed in the form of cash or stock. Both forms of distribution reduce retained earnings. ꦕCash dividends result in cash outflows and are recorded as net reductions. As the company loses liquid assets in the form of cash dividends, its asset value is reduced on the balance sheet, thereby impacting RE.

On the other hand, the stock payment transfers part of the retained earnings to common stock. For instance, if a company pays one share as a dividend for each share held by the investors, the price per share will be cut in half because the number of shares will double. Because the company has not cr🐲eated any real value simply by announcing a stock dividend, the per-share market price is adjusted according to the proportion of the stock dividend.

A growth-focused company may pay small dividends or no dividends at all, pr༒eferring to use retained earnings to finance activities such as research and development (R&D), marketing, working capital requirements, capital expenditures, and acquisitions to achieve additional growth. Such companies have high retained earnings over the years.

A maturing company may not have many options or high-return projects for which to use the surplus cash, and it may pref🌳er handing out dividends. Such companies tend to have low RE.

What Is th🍒e Difference Betweeꦗn Retained Earnings and Revenue?

Both revenue and retained earnings are important in evaluating a company’s financial health, but they highlight different aspects of the financial picture. Revenue sits at the top of the income statement and is often🌌 referred to as the top-line number when describin⛎g a company’s financial performance.

Revenue is the money generated by a company during a period but before operating expenses and overhead costs are deducted. In some industries, revenue is called 澳洲幸运5官方开奖结果体彩网:gross sales because the gross figure is calculated before any deductioꦍns.

Retained earnings are the portion of a company’s cumulative profit that is held or retained and saved for future use. Retained earnings could 🌺be used to fund an expansion or pay dividends at a later date. Retained earnings are related to net (as opposed to gross) income because they reflect the net income the company has saved over time.

What Are the Limitations of Retained Earnings?

For an analyst, the absolute figure of retained earnings during a particular🍌 quarter or year may not provide any meaningꦯful insight. Observing it over a period of time (for example, over five years) only indicates the trend of how much money a company is adding to retained earnings.

As an investor, one would like to know much more, such as the returns that the retained ea♋rnings have generated and whether they were better than any alternative investments. Additionally, investors may prefer to see larger dividends rather than significant annual i✅ncreases to retained earnings.

What Is Retained Earnings to Market Value?

One way t𝄹o assess how successful a company is in using retained earnings is to look at a key factor called retained earnings to market value. It is calculated o❀ver a period (usually a couple of years) and assesses the change in stock price against the net earnings retained by the company.

For example, during the period from September 2021 through September 2024, Apple Inc.’s (AAPL) stock price rose from around $143 per share to around $227 per share. In the same period, the company issued $2.82 of dividends per share, while the total earnings per share (diluted) was $18.32.

The difference between total EPS and total dividend gives the net earnings retained by the company: $18.32 - $2.82 = $15.50. That is, over that time period, the company retained a total of $15.50 earnings per share.

Over the same duration, its stock price rose by $84 ($227 - $143) per share. Dividing this price rise per share by net earnings retained per share gives a factor of 5.42 ($84 ÷ $15.50), which indicates that for each dollar of retained earnings, the company managed to create around $15.50 of market value.ꦜ

If the company had not retained this money and instead taken an interest-bearing loan, the value generated would have been less due to the outgoing interest payment. Retained earnings offer internally generated capital to finance projects, allowing for efficient value creation by profitable companies. However, note that the above calculation is indicative of the value created with respect to the use of retained earnings only, and it does not indicate the overall value created by the company.

Retained Earnings Example

Companies publicly record their retained earnings (or accumulated deficit) under the 澳洲幸运5官方开奖结果体彩网:shareholders’ equity section on the 澳洲幸运5官方开奖结果体彩网:balance sheet. For instance, Apple’s balance sheet from the end of the 2024 fiscal year shows that the company had an accumulated deficit of $19.1 billion as of the end of September 2024:

Similarly, the iPhone maker, whose fiscal year ends in September, had an accumulated deficit of $214 million at the end of September 2023.

The retained earnings are calculated by adding net income to (or subtracting net losses from) the previous term’s retained earnings and then subtracting any net dividend(s) paid🏅 to the shareholde🃏rs.

The figure is calculated at the end of each accounting period (monthly, quarterly, or annually). As the formula suggests, retained earnings are dependent on the corresponding figure of the previous term. The resultant number may be either positive or negative, depending on the 澳洲幸运5官方开奖结果体彩网:net income or loss generated by the company over time. Alternatively, the company paying large dividends that exceed the other figures can also lead to the retained earnings g꧒oing negative. 

Any item that impacts net income (or net loss) will impact the retained earnings. Such items include sales revenue, 澳洲幸运5官方开奖结果体彩网:cost of goods sold (COGS), 澳洲幸运5官方开奖结果体彩网:depreciation, and necessary 澳洲幸运5官方开奖结果体彩网:operating expenses.

The Bottom Line

Retained earnings represent the profit a company has saved over time and therefore the portion that can be used to reinvest in the business (in new equipment, R&D, or marketing, among others) or distributed to shareholders. They are a measure of a company's financial health, and they can promote stability and growth.