How to Prepare a Retained Earnings Statement

A retained earnings statement provides a snapshot of how a company’s accumulated profits have changed over a specific period. It outlines how much profit a company keeps and reinvests back into its operations versus how much it distributes to its owners or shareholders. Understanding this statement offers insights into a company’s financial decisions and its capacity for future growth without external funding.

Understanding Retained Earnings

Retained earnings represent the accumulated net income of a company that has not been distributed to shareholders as dividends. This figure is a portion of the company’s equity and is reported on the balance sheet. Businesses retain earnings for various purposes, primarily to reinvest in the company’s operations and support its long-term growth.

Companies often use retained earnings to fund significant investments, such as purchasing new equipment, expanding facilities, or investing in research and development for new products. These funds can also be allocated to reduce debt obligations. Retained earnings can serve as a financial buffer, allowing a company to navigate economic downturns or pursue strategic opportunities without reliance on external financing. Tracking retained earnings is important for stakeholders, as it reveals a company’s approach to capital allocation and its commitment to internal financing for future endeavors.

Key Elements of the Statement

A retained earnings statement details components that influence the change in accumulated profits. The starting point for this statement is the beginning retained earnings balance. This figure represents the accumulated profits from all prior periods that were carried forward, serving as the ending balance from the previous accounting cycle.

The net income or net loss for the current period is another element. Net income, derived directly from the income statement, increases retained earnings, while a net loss decreases it. Dividends declared to shareholders during the period also impact retained earnings. These distributions, whether cash or stock, reduce the retained earnings balance. Prior period adjustments may appear, which are corrections of errors from previous financial statements. Such adjustments directly affect the beginning retained earnings balance to ensure accuracy.

Constructing the Retained Earnings Statement

Preparing a retained earnings statement involves a clear, sequential process that reconciles the beginning and ending balances of retained earnings for a specific period. The process begins by identifying the retained earnings balance from the close of the previous accounting period. This figure is typically found on the prior period’s balance sheet.

The net income for the current accounting period is added to this beginning balance. If the company incurred a net loss instead of income, this amount would be subtracted from the beginning balance. Subsequently, any dividends declared and paid to shareholders during the period are subtracted. Dividends, whether in cash or additional shares, reduce the amount of earnings retained by the business.

For example, consider a company with a beginning retained earnings balance of $100,000 at the start of the year. If the company earned a net income of $50,000 during the year and declared $10,000 in dividends, the calculation would proceed as follows: $100,000 (Beginning Balance) + $50,000 (Net Income) – $10,000 (Dividends). The resulting ending retained earnings balance for the period would be $140,000.

Role in Financial Reporting

The retained earnings statement serves as a bridge between a company’s profitability and its financial position, connecting several key financial reports. Net income or net loss, which is the result of a company’s operations as detailed on the income statement, directly flows into the retained earnings statement. This connection highlights how current period earnings contribute to the cumulative profits retained by the business.

The ending balance of retained earnings from this statement is then carried over and presented as a crucial component of the shareholders’ equity section on the balance sheet. Decisions regarding retained earnings, such as dividend payouts versus reinvestment, can influence a company’s cash flow activities. The statement provides a comprehensive view of how a company’s profits are managed and reinvested, offering valuable insights into its financial health and capacity for self-funded growth.