Retained Earnings

Retained Earnings

What are retained earnings?

Retained earnings are the cumulative net income a company keeps after paying dividends to shareholders. They represent profits that have been reinvested in the business or held as reserves rather than distributed.

Formula and key ratios

Retained earnings are updated each accounting period using:
RE = Beginning Period RE + Net Income (or Loss) − Cash Dividends − Stock Dividends

Retention ratio (the proportion of earnings kept) = 1 − Dividend Payout Ratio

Where they appear on the financial statements

Retained earnings are reported in the shareholders’ equity section of the balance sheet. They are equity (not an asset) but can be used to acquire assets, pay debt, buy back shares, or pay future dividends.

Common uses of retained earnings

Companies commonly use retained earnings to:
* Fund expansion (capital expenditures, new plants, capacity increases)
* Finance R&D, marketing, or product launches
* Repay long-term debt
* Execute mergers, acquisitions, or strategic partnerships
* Repurchase shares
* Hold as reserves for future needs

Management vs. shareholders

Management typically decides whether to retain earnings or distribute dividends, though shareholders can influence policies (e.g., by voting). Growth-oriented firms often retain more earnings to fund expansion, while mature firms may distribute larger dividends.

Differences from related terms

• Retained earnings vs. revenue: Revenue is the top-line (gross) amount earned in a period. Retained earnings are cumulative net income minus dividends — a balance-sheet equity item.
• Retained earnings vs. profits/net income: Net income is the profit for a period. Retained earnings are the accumulated portion of net income kept by the company after dividends.
• Retained earnings vs. dividends: Dividends (cash or stock) reduce retained earnings. Cash dividends reduce company assets; stock dividends reallocate equity without changing total value.

Interpreting retained earnings

• Positive and growing retained earnings often indicate past profitability and available internal capital for growth.
• Negative retained earnings (an accumulated deficit) signal historical losses or dividends exceeding profits and can indicate financial weakness.
• High retained earnings may reflect solid profitability or a management choice to reinvest rather than reward shareholders — context matters.

Limitations

• A single retained earnings figure is of limited use. Trends over multiple periods and the returns generated from reinvested earnings are more informative.
• Investors should assess whether retained earnings were deployed effectively (i.e., whether reinvestment produced returns exceeding alternative uses such as dividends or debt repayment).

Retained earnings to market value (illustrative concept)

This ratio compares market value change to net earnings retained over a period to gauge how effectively retained earnings created shareholder value. Example: if a company retained $15.50 per share over a period and its share price rose $84, the price increase divided by retained earnings (84 ÷ 15.50 ≈ 5.42) implies each $1 retained coincided with about $5.42 of market value gain. This measure is indicative, not definitive, because market price movements reflect many factors beyond retained earnings.

Example note

Companies disclose retained earnings (or accumulated deficits) in annual reports. For example, a large company may report an accumulated deficit on its balance sheet in some years due to accounting items, share repurchases, or dividend policy decisions.

Key takeaways

• Retained earnings are accumulated profits kept by a company after dividend payments.
• They appear in shareholders’ equity and fund reinvestment, debt repayment, buybacks, or dividends.
• Assess retained earnings over time and evaluate how effectively the company converts retained earnings into returns or market value.
• Negative retained earnings warrant scrutiny; high retained earnings may be positive or a signal that more dividends could be appropriate depending on growth opportunities.