'Retained Earnings' is explained in detail and with examples in the Corporate Finance edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
Retained earnings are a component of the earnings categories of corporations. They describe the portion of a company’s net earnings that they do not give out to shareholders as dividends. Instead these earnings are kept by the firm so that they can pay down debt or reinvest in their core operations and business model. Balance sheets note earnings which are retained as part of the shareholder’s equity column.
There is a formula for figuring out retained earnings. It adds the initial earnings with net income or subtracts net losses from it. Dividends must then be subtracted out from these earnings as they are paid out to stockholders.
Corporations have their reasons to keep a portion of their earnings. In the majority of scenarios, they wish to invest them into segments of the market where the firm is able to build opportunities or growth. This could be by spending money for additional research and development or in purchasing new plants, equipment, or machinery. Companies can also use these earnings to purchase other firms. Such acquisitions allow them to expand their market share or product offerings in this method of non organic growth.
It is possible for such earnings to become negative. This happens when the firm’s net loss is larger than the initial retained earnings. Such a case creates a deficit. The general ledger for these earnings becomes adjusted each time an entry is placed for the expense or revenue accounts.
At the conclusion of the company’s accounting period, such earnings that are retained become reported. This could be in the quarterly report or the annual report. They will either continue to be accumulated and be positive, or they can shift into negative territory and be recorded as a deficit. These changes in earnings from one accounting period to the next are not directly noted. It is easy to infer them by looking at the totals of ending and beginning retained earnings for the accounting period. Increases or decreases to the accumulated totals happen because of dividend payouts and net losses or net incomes for the period.
Every period, a firm’s revenues and expenses must be closed out. This is done into an income summary that shows the total net income or loss. Finally these are closed out into the retained earnings column. Net income directly boosts or decreases these earnings this way.
Dividends are the other major item that decreases the retained earnings number. Such dividends can be paid out as stock or cash. Either type reduces the earnings which are retained. This is because cash dividends come out of the net income ultimately. The greater amount of dividends that a company distributes, the lower amount of earnings it will retain. Dividend accounts are also temporary in nature and are closed out to the earnings which are retained at the end of the accounting period.
Though newly issued shares given out as dividends do not reduce the net income, they must be reconciled on the balance sheet. This is done in the accounts for additional paid in capital on the balance sheet. The earnings which are retained category decreases by the identical amount as this paid in capital column.
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