What are Retained Earnings?
Retained Earnings represent a company’s accumulated profits that it has not distributed as dividends to its shareholders. These are profits that the company holds to reinvest into its business. Retained earnings are an internal source of capital that it uses for short-term capital needs. These may include using it for working capital requirements or even short-term debt pay-offs.
Usually, companies report their retained earnings on their Balance Sheets under Shareholder’s Equity section. At the end of each accounting period, companies add their net income to their retained earnings. Similarly, they deduct any dividend payments to shareholders from the balance.
Some companies may also present their retained earnings balance in the Statement of Retained Earnings. It is a statement that they produce along with the Balance Sheet.
What is the Statement of Retained Earnings?
A company’s Statement of Retained Earnings provides an overview of the changes in its retained earnings for a specific period. The statement starts from the retained balance in the previous period and shows any adjustments made to it during the year. These adjustments may come in various forms, such as additions or deductions in net income, dividend payments, etc.
After the adjustments, the Statement of Retained Earnings reports the company’s closing retained earnings balance. This closing balance makes the opening balance for the next period. Similarly, the closing balance on the statement must match the retained earnings balance on the Balance Sheet.
The Statement of Retained Earnings may come in various forms, depending on accounting standards. Sometimes, companies may append the statement to the Balance Sheet or Income Statement. Similarly, it may also come as a standalone statement. Some companies may also use the Statement of Changes in Owner Equity instead of the retained earnings.
The primary stakeholders interested in the Statement of Retained Earnings are a company’s shareholders or investors. Sometimes, lenders may also require companies to prepare a Statement of Retained Earnings. However, investors can get most of the information reported in the statement from other primary financial statements. The main point of interest for them from this statement is the dividends figure presented in it.
Example of Statement of Retained Earnings
A company, Red Co., had an opening retained earnings balance of $900,000. During the year ended December 31, 2020, the company reported a net income of $300,000 in its Income Statement. The company also paid dividends to its shareholders, amounting to $200,000. Therefore, the company’s Statement of Retained Earnings, in its simplest form, will be as follows.
| Red Co. | |
| Statement of Retained Earnings | |
| For the year ended December 31, 2020 | |
| Retained earnings at December 31, 2019 | $ 900,000 |
| Net income for the year ended December 31, 2020 | $ 300,000 |
| Dividends paid to shareholders | $ (200,000) |
| Retained earnings at December 31, 2020 | $ 1,000,000 |
The above Statement of Retained Earnings is simplified. Companies may also use the statement to report the changes in other equity balances, such as paid-in capital, additional paid-in capital, etc.
Conclusion
Retained earnings represent the accumulated profits of a company that it has not distributed to shareholders as dividends. Companies may report their retained earnings in the Balance Sheet. However, they may also use the Statement of Retained Earnings to show the movement in the balance. The Statement of Retained Earning is one of the primary statements that companies use to report their activities.
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