How to Get Retained Earnings and How to Use Them

Retained earnings are the cumulative profits a business has accumulated over time that have not been distributed to shareholders as dividends. This financial resource indicates a company’s financial well-being and its ability to fund future growth. Understanding retained earnings provides insight into how a company manages its profitability and plans for its future.

What Retained Earnings Are

Retained earnings are the portion of a company’s accumulated profits remaining after all expenses and dividends to shareholders. These funds are an internal source of capital, which can reduce a company’s reliance on external financing like loans or issuing new equity. A consistent increase in retained earnings often indicates strong financial management and profitability, contributing to financial stability and flexibility.

The basic calculation for retained earnings involves a straightforward formula. Begin with the retained earnings balance from the previous accounting period. To this amount, add the net income (or subtract a net loss) generated during the current period. Finally, any dividends paid to shareholders during the period are subtracted. For instance, if a company starts with $100,000 in retained earnings, earns $50,000 in net income, and pays $20,000 in dividends, its ending retained earnings would be $130,000.

Finding Retained Earnings on Financial Statements

Retained earnings are a specific line item that can be located within a company’s financial reports. On the balance sheet, retained earnings appear as a component of owner’s equity, typically listed under the “Equity” or “Shareholder’s Equity” section. The balance sheet figure represents the total cumulative profits that have been reinvested in the business up to a specific point in time.

A more detailed view of how retained earnings change over a period is provided by the Statement of Retained Earnings. This statement reconciles the beginning and ending retained earnings balances for a specific accounting period. It shows the starting retained earnings, adds the net income from the income statement, and then subtracts any dividends paid, ultimately arriving at the ending balance.

A growing retained earnings balance over time suggests that a company is consistently profitable and choosing to reinvest a significant portion of its earnings back into its operations. Conversely, a declining or negative balance, known as an accumulated deficit, might signal operational losses or substantial dividend payouts relative to profits.

How Businesses Use Retained Earnings

Businesses strategically utilize retained earnings to fuel their operations and pursue growth opportunities. A common application is reinvestment directly into the business, which can take various forms. Companies often use these funds for capital expenditures, such as purchasing new property, equipment, or machinery, to expand production capacity or modernize facilities. This internal financing allows for business expansion, including opening new locations or entering new markets, without incurring additional debt or diluting ownership through external financing.

Another significant use of retained earnings is for research and development (R&D) activities. Investing in R&D enables companies to innovate, develop new products or services, and enhance existing ones, which can provide a competitive advantage and drive long-term growth. Retained earnings can also be allocated to marketing campaigns to reach new customers or to pay down existing debt, thereby improving financial stability and reducing interest expenses. Some businesses also use these funds for mergers and acquisitions or to buy back their own stock, further consolidating ownership or enhancing shareholder value.

While reinvestment is a primary use, a portion of retained earnings can also be distributed to shareholders in the form of dividends. The decision to pay dividends is typically made by the company’s board of directors, considering factors like current profitability, future investment needs, and shareholder expectations. This distribution represents a direct way shareholders receive a share of the company’s accumulated profits. Companies must balance the decision to reinvest profits for future growth against returning capital to shareholders, a choice often influenced by the company’s growth stage and overall financial health.