Retained Earnings
What Are Retained Earnings?
Retained earnings are the portion of a company’s net income that is not paid out as dividends, but is instead reinvested back into the business.
This can be used to finance new growth initiatives, pay down debt, or for other purposes.
Retained earnings belong to the shareholders of a company, and can be distributed to them through share repurchases or other methods.
The formula for retained earnings is:
RE = Net Income – Dividends Paid Out
Where:
- RE = retained earnings
- Net Income = total company profits, and
- Dividends Paid Out = dividends declared and paid to shareholders
If a company has been cumulatively profitable in excess of its total losses, it will have accumulated retained earnings on its balance sheet.
Which Transactions Affect Retained Earnings?
There are several types of transactions that can affect a company’s retained earnings.
These include:
Revenues and expenses
Net income represents the total amount of revenue earned by a company minus all expenses incurred.
Therefore, any changes in revenue or expenses will impact retained earnings.
Dividends
Dividends are payments made to shareholders out of a company’s profits.
As dividends are paid out of net income, they will reduce retained earnings.
Share repurchases
When a company buys back some of its issued and outstanding stock, the transaction impacts retained earnings in an indirect way.
Retained earnings and treasury stock are part of the stockholders’ equity section of the balance sheet, so the amount of funds available to pay dividends declines.
What Is the Purpose of Retained Earnings?
There are a few different purposes for which companies can use their retained earnings.
These include:
Financing growth
One of the most common uses for retained earnings is to finance growth initiatives.
This can include expanding into new markets, developing new products, or investing in new technologies.
By reinvesting profits back into the business, companies can fund these initiatives without taking on additional debt.
Paying down debt
Another common use of retained earnings is to pay down outstanding debts and loans.
This can help to improve a company’s financial health and reduce its interest payments.
Distributing to shareholders
Finally, retained earnings can also be distributed to shareholders in the form of share repurchases or dividends.
This can provide a return on investment for shareholders and help to ensure that they remain invested in the company.
When Should Retained Earnings Be Paid Out?
There is no hard and fast rule for when retained earnings should be paid out.
Ultimately, it is up to the Board of Directors to decide how best to use these funds.
However, there are a few factors that can impact this decision, such as the needs of the business and the wishes of shareholders.
The needs of the business
If a company is in need of cash to fund growth initiatives or pay down debt, it may be best to retain earnings rather than distribute them.
The wishes of shareholders
If shareholders are looking for a return on their investment, the company may choose to pay out dividends or repurchase shares.
Tax considerations
Finally, tax considerations can also play a role in the decision of when to pay out retained earnings.
Dividends are typically taxed at a lower rate than other forms of income, so companies may choose to distribute these funds to shareholders rather than reinvest them back into the business.
Retained earnings can be a valuable tool for companies looking to finance growth or pay down debt.
However, there is no one-size-fits-all answer for when these funds should be paid out.
The decision of when to distribute retained earnings should be made on a case-by-case basis, taking into account the needs of the business and the wishes of shareholders.
Return on Retained Earnings (RORE)
The return on retained earnings (RORE) is a measure of the profitability of a company’s reinvestment strategy.
It is calculated as:
RORE = (most recent EPS – first period EPS) / (cumulative EPS for the period – cumulative dividends paid for the period)
The RORE can be a useful metric for evaluating a company’s ability to generate returns on its investment.
A high RORE indicates that the company is able to generate a significant return on its reinvested earnings.
How Does the RORE Affect Shareholders?
The RORE can have a direct impact on shareholders.
A high RORE indicates that the company is able to generate strong returns from its reinvestment activities.
This can lead to higher dividends and share price, as well as increased value for shareholders.
Conversely, a low RORE indicates that the company is not generating adequate returns on its reinvested earnings.
This can lead to lower dividends and share price, and decreased value for shareholders.
The RORE is an important metric for evaluating a company’s investment strategy.
A high RORE indicates that the company is able to generate strong returns from its reinvestment activities.
This can be beneficial for shareholders, as it can lead to higher dividends and share prices.
What Is a Good RORE?
There is no one-size-fits-all answer to this question, as the definition of a “good” RORE will vary from company to company.
However, a general guideline is that a RORE of 10 percent or higher is considered to be good.
What Financial Statement Lists Retained Earnings?
The retained earnings statement is located on a company’s balance sheet and lists the cumulative earnings (or losses) of a company.
The retained earnings account can be found in the quarterly and annual reports of a public company.
It is an important financial document that provides insights into a company’s profitability and reinvestment strategy.
Shareholders and investors use this information to evaluate a company’s performance and make investment decisions.
Appropriated Retained Earnings
Appropriated retained earnings are funds that have been set aside by the board of directors for a specific purpose.
Typically, these funds are earmarked for future investment or expansion plans.
Appropriated retained earnings can be a useful tool for companies looking to finance growth or expand their operations.
By setting aside these funds in advance, companies can avoid the need to raise additional capital through debt or equity financing.
Appropriated retained earnings are not available for distribution to shareholders.
This means that they cannot be used to pay dividends or repurchase shares.
Instead, these funds must be reinvested back into the company.
Appropriated retained earnings can be a valuable source of funding for companies looking to expand their operations.
However, it is important to note that these funds cannot be used to pay dividends or repurchase shares.
Unappropriated Retained Earnings
Unappropriated retained earnings are funds that have not been set aside by the board of directors for a specific purpose.
These funds are available for distribution to shareholders in the form of dividends or share repurchases.
Unappropriated retained earnings can be a useful source of funding for companies looking to return cash to shareholders.
By paying dividends or repurchasing shares, companies can reduce the number of outstanding shares, which can lead to an increase in share price.
Unappropriated retained earnings are not typically used to finance expansion or growth plans.
Instead, these funds are typically returned to shareholders through dividends or share repurchases.
Dividends vs. Share Repurchases
Dividends and share repurchases are two common ways for companies to return cash to shareholders.
Dividends are periodic payments that are made to shareholders from a company’s profits.
Dividends are typically paid out quarterly, but can be paid more or less frequently depending on the company’s policy. Some companies pay out dividends monthly.
Share repurchases involve a company buying back its own shares from shareholders.
This reduces the number of outstanding shares, which can lead to an increase in share price.
Both dividends and share repurchases can be financed from a company’s unappropriated retained earnings.
Which Is Better: Dividends or Share Repurchases?
There is no one-size-fits-all answer to this question.
Each company has its own unique circumstances that will dictate whether dividends or share repurchases are the best way to return cash to shareholders.
Some factors that companies should consider when making this decision include:
- The company’s financial condition
- The company’s tax liability
- The company’s reinvestment needs
- Shareholder preferences
Ultimately, the decision of whether to pay dividends or repurchase shares depends on a variety of factors and should be made on a case-by-case basis.
Revenue vs. Retained Earnings: What’s the Difference?
Revenue and retained earnings are two important financial concepts that are often used interchangeably.
However, these two terms have different meanings and implications.
Revenue is the total amount of money that a company brings in from its business activities.
This can come from sales of goods or services, interest income, or other sources.
Retained earnings are the portion of a company’s profits that are not distributed to shareholders.
These funds can be reinvested back into the company or used to pay dividends.
While revenue and retained earnings are related, they are not the same thing.
Retained Earnings – FAQs
What Is Retained Earnings?
Retained earnings are the portion of a company’s profits that are not distributed to shareholders.
These funds can be reinvested back into the company or used to pay dividends.
How Is Retained Earnings Calculated?
Retained earnings is calculated by taking a company’s net income and subtracting any dividends that have been paid out.
This number can then be carried over to the next period to calculate the retained earnings for that period.
Why Are Retained Earnings Important?
Retained earnings are important because they represent the portion of a company’s profits that can be used to finance any growth and expansion plans.
By reinvesting these funds back into the business, companies can fuel their growth without having to rely on outside financing, which creates additional liabilities.
What Are the Different Types of Retained Earnings?
There are two main types of retained earnings: unappropriated and appropriated.
Unappropriated retained earnings are funds that have not been specifically earmarked for a particular purpose.
These funds can be used for any number of purposes, including dividends or share repurchases.
Appropriated retained earnings are funds that have been set aside for a specific purpose, such as funding expansion plans or repaying debt.
How Do Dividends Affect Retained Earnings?
Dividends affect retained earnings because they represent a distribution of profits to shareholders.
When a company pays dividends, the amount of money available for retention decreases.
This can impact a company’s ability to finance growth or expansion from its retained earnings.
What Is the Difference Between Revenue and Retained Earnings?
Revenue represents the total amount of money coming into a company, while retained earnings represent the portion of profits that are not paid out to shareholders.
What Are the Pros and Cons of Having Retained Earnings?
The pros of retained earnings are that they can be used to finance growth or expansion without incurring debt.
The cons of retained earnings are that they can tie up cash that could be used for other purposes, such as dividends or share repurchases.
What Happens to Retained Earnings When a Company Is Sold?
When a company is sold, what happens to the company’s cash balance depends on the terms of the sale.
They may be paid out to existing shareholders or they may be carried over to the new owner, depending on the terms of the sale.
How Are Retained Earnings Taxed?
Retained earnings are not taxed until they are distributed to shareholders as dividends. Dividends are taxed at the shareholder’s individual tax rate.
For example, if a company has $1,000 in retained earnings and pays out $500 in dividends, the shareholder would be taxed on $500 of dividend income.
Are There Any Risks Associated With Retained Earnings?
There are a few risks associated with retained earnings.
First, if a company has a large amount of retained earnings, it may be difficult to find enough good investment opportunities to reinvest these funds.
Essentially, cash may pile up, which carries an opportunity cost.
Cash is the worst investment over the long run and its return is significantly eaten up by inflation and taxes on the interest over time.
Second, if a company pays too much in dividends, it may not have enough retained earnings to fund future growth or make accretive acquisitions.
Finally, if a company is sold, the retained earnings may be paid out to shareholders as part of the sale proceeds.
This could result in a tax bill for the shareholders if the dividend income is taxable.
What Happens When Retained Earnings Are Negative?
When retained earnings are negative, it means that a company has lost money over time.
This can happen for a number of reasons, including a focus on growth over profit, bad investments, poor management, or an industry or economy-wide downturn.
If a company’s retained earnings are negative, it may be difficult to raise new capital, as investors may be reluctant to invest in a company that has a history of losses.
How Can I Access My Company’s Retained Earnings Statement?
Your company’s retained earnings can be found in its financial statements (i.e., the balance sheet).
This information is typically available on the company’s website or from your broker or financial advisor.
Summary – Retained Earnings
Retained earnings is the portion of a company’s profits that are not paid out as dividends, but instead held back by the company.
This can be done for a variety of reasons, including reinvesting the earnings back into the business, repaying debt, or paying out special dividends.
There are a few key things to remember about retained earnings:
- They represent a portion of a company’s profits
- They can be used for a variety of purposes, including reinvestment, debt repayment, and special dividends
- Retained earnings can impact a company’s stock price
The amount of retained earnings a company has can give insight into its financial health and growth potential.
A company with a large amount of retained earnings is able to reinvest in itself and grow without having to rely on external financing.
Conversely, a company with little or no retained earnings may be struggling financially and have difficulty expanding without borrowing money.
If you’re considering investing in a company, it’s important to look at its retained earnings to get an idea of how the company is using its profits.