Statement of Retained EarningsDefined along with Examples

Written By:
Lisa Borga

What is a Statement of Retained Earnings?

A statement of retained earnings is a financial statement that shows the changes that occur in the retained earnings account during the period of time covered by the financial statement.

The financial statement uses information including net income, which is obtained from other financial statements, to reconcile both the beginning, as well as the ending, retained earnings for the period covered by the financial statement.

This information can be used by analysts or investors to see how a business uses its profits.

A statement of retained earnings is also sometimes called a statement of owner’s equity, a statement of shareholders’ equity, or an equity statement.

Generally Accepted Accounting Principles are followed when preparing this statement.

Explanation of Statement of Retained Earnings

A statement of retained earnings is sometimes included on the balance sheet or on the income statement, and other times companies provide this statement separately.

This statement includes items such as a company’s retained earnings, its net income, and the amount the company has distributed as dividends to its shareholders.

When the business’s net income is shown, the statement will also indicate any losses that need to be covered, as well as show the amount of any other obligations the business will set aside money for other than dividend payments.

The statement of retained earnings covers a specific period of time which is indicated on the statement.

Retained Earnings

Retained earnings are sometimes called accumulated retained earnings, retained profits, or accumulated earnings.

These earnings are frequently either reinvested in the company to help the company grow or used to help pay a company’s debts.

When a company has sufficient earnings, some of the stockholders may expect the company to pay dividends with part of these earnings to reward them for investing in the business.

Additionally, those investors that wanted short-term profits may want dividend payments as well to achieve this goal.

Dividends are paid to investors from a company’s profits.

Therefore, paying dividends does reduce a business’s retained earnings.

A business has a lot of options for what it can do with the profits it keeps as retained earnings, such as:

• The money could be used to invest in expanding the current operations of the company, such as hiring more employees or improving production capacity.
• The money could also be used to invest in research for developing new products, such as a candy bar manufacturer releasing a new type of candy bar or a soda manufacturer releasing a new flavor of soda.
• The retained earnings could also finance an acquisition or a merger.
• Sometimes, companies use the money for share buybacks.
• Another use for retained earnings would be to pay off loans or other debts the business has acquired.

Retained earnings are the profits a business makes and then keeps to use within the company.

Advantages of the Statement of Retained Earnings

A statement of retained earnings is generally released to help increase the confidence of investors as well as the market in the company.

Investors can use this information to help determine if a business is healthy.

Retained earnings are not really extra money; they are earnings that are frequently used to reinvest in the company.

In a company that is growing or is part of a capital-intensive industry, retained earnings will probably be higher than they would be for more stable companies or those in less capital-intensive industries.

This is often a result of more money being spent on asset development in businesses in a capital-intensive industry or in a period of high growth.

An example of this would be a company that develops new computer technology versus a company that produces hats.

The computer technology company would probably need to spend more money on asset development than the hat company because of the different ways in which they view product development.

The hat company is unlikely to need to make a lot of changes in their product.

In contrast, a computer technology company will probably need to continually make changes to remain competitive in the industry.

This means that the computer technology company would probably keep more of its profits as retained earnings than the hat company would.

The Retention Ratio

Aside from the advantages listed above, there’s another piece of useful information you can get from a statement of retained earnings, the retention ratio.

The retention ratio allows investors to know the amount of money a business has kept to reinvest in the business.

By calculating this ratio, you can find the proportion of the income that the company has decided to reinvest instead of distributing as dividends.

This money can then be used to help the business grow.

There is another ratio, the payout ratio, which gives investors the opposite information, the amount of earnings paid out as dividends to stockholders.

Investors can use the retention ratio to let them see the amount of money that a business is choosing to reinvest in its operations.

This can be useful information since if a company chooses to pay all of its profits out as dividends instead of investing part of these profits, the company may not have good earnings growth in the future.

Additionally, a business that does not do a good job of managing its retained earnings may need to obtain a loan or issue new stock in order to finance its growth.

Due to these issues, investors should look at the retention ratio along with other financial metrics to see if a company is worth investing in.

The retention ratio is certainly an important part of determining if a company is retaining enough of its earnings to finance growth.

However, it is possible for a company to keep too much of its earnings when the business might do better to invest in technology, new product lines, or equipment.

When companies are just starting out, they generally do not pay dividends because they need this money to finance growth.

However, more established companies often do pay part of their retained earnings out as dividends and keep the rest to reinvest in the business.

Key Highlights

• Retained earnings are the earnings a business has left over to reinvest in the company after distributing dividends to stockholders.
• A statement of retained earnings refers to a financial statement that shows the changes in a company’s retained earnings during a specific period of time.
• Investors or analysts can use the statement of retained earnings to determine whether a company pays dividends out on a regular basis and whether it is keeping enough of its profits to invest in growing the company.