Retained earnings are net earnings that are not distributed to shareholders and that the company decides to reinvest.
Retained earnings are those net earnings that the company decides not to distribute as dividends among its shareholders.
Retained earnings are used for reinvestment in the form of equipment, research and development, and other items such as paying financial obligations. One of the purposes, also, is to preserve the liquidity of the company.
Many companies turn to retained earnings as a way of financing the company, as it is an effective way to avoid the outflow of money and having to resort to new obligations (that is, more debt).
The retained earnings belong to the capital of the shareholders. They are calculated by adding net income to initial retained earnings and subtracting dividends paid to shareholders.
The retained earnings are part of the net worth of the company. And this is how it is reflected in the balance sheet.
Retained Earnings Calculation With Example
Let us assume that your company started on February 1, 2020. That time your retained earnings balance will read $0, as you have no earnings to include.
Suppose we assume that your earnings for January are $2000 in net income per your income statement and without any issuance of dividends. That complies that on March 1, retained earnings of your company will be $2000.
If we put the above values in the retained earnings equation, we derive:
$0 + $2000 - $0 = $2000
*You earned $2000 and retained all of them which becomes your retained earnings.
Vivek is a Digital Marketing expert and social media enthusiast.