Retained earnings are referred to as that part of earnings or profit that is not distributed to the shareholders as dividends. These profits are reinvested in the business towards working capital requirements and for purchasing of fixed assets. It can also be used for paying off any kind of debt obligations.
Retained earnings are reflected in the balance sheet under the shareholders equity. It is also known as the earning surplus. In ideal situations, a company should retain its profits if the company is able to generate higher profits for the shareholders by the process of reinvesting profits.
It is necessary to calculate the retained earnings at the end of each accounting period.
Retained earnings help in determining the dividend policy of the company as it reflects the company’s decision on whether to reinvest profits or pay the profit as dividends to shareholders.
The extent to which retained earnings will be utilised depends on the type of industry and the age of business. It is generally observed that industries that are capital intensive and start-ups tend to retain most of the earnings as they utilise it towards business as the company requires more assets in order to perform.
It is observed that older companies have a significantly higher retained earnings than newly established companies as retained earnings are a part of the profit that the business earns since its inception.
Retained Earnings Formula
Retained Earnings = Beginning Period RE + Net Income/Loss – Cash Dividends – Stock Dividends
Or
RE = Beginning Period RE + Net Income/Loss – Cash Dividends – Stock Dividends
Where,
RE= Retained earnings
Retained Earning Example
Following is an example of retained earnings :
Company ABC reports the following items for 2020:
₹
Net Income 5,000.0
Retained Earnings (2019) 3,000.0
Cash Dividends 1,500.0
RE = Beginning Period RE + Net Income/Loss – Cash Dividends – Stock Dividends
= ₹ 3,000.0 + 5,000.0 – 1,500.0
= ₹ 6,500
This concludes the topic of Retained Earnings, which is an important component of Business Studies for the students of Commerce. For more information, stay tuned to BYJU’S.
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