What are retained earnings?

Banking & Finance

Retained earnings are the business earnings that are not a part of the profit distribution process in between the shareholders rather it is secured profit that is used for business activities. The firm stores the retained earnings in the business bank which cannot be used by shareholders for their personal use, it’s used for business use It is an amount which is taken out from the firm which is not included in the part of profit distribution to the stakeholders, it is secured to make a better financial year in the end to cover all losses.

Motive of retained earnings

Retained Earnings represent its own value in the business, it is that kind of working capital that is used for emergencies, otherwise added to net income at the end of the financial year. Sometimes, when a firm suffers from major losses, the retained earnings are used to cover those losses to balance the firm’s financial health. If it is distributed, then the firm will not have secure money for reinvestment on the same project or cover losses. In that case, the company will sink very badly. Basically, retained earnings maintain two statements together ie. income statement and balance sheet, both are major affected when the entry of retained earnings are passed. The income increases when retained earnings add into net income, and the equity increases when retained earnings add into shareholder’s equity.

The motive of retained earnings is to increase the productivity level by investing as working capital on assets and equipment to purchase, investing in share markets for business outer growth, investing in hiring consultants, and adopting new technologies. All these activities help firms to achieve large growth in less time and give hope to earn more capital in the future so that they can invest in new business projects.

How to calculate RE by using formulas?

Retained Earnings = Starting period of RE + Net Income/Net Loss – Cash dividends- Stock dividends

Where retained earnings are recorded?

Retained earnings are a small part of the profit that is saved at one time in a financial year and recorded under two statements which are the income statement and balance sheet.

Where retained earnings found under income statement?

When you take out a small part of an amount from a firm’s profit after paying dividends or other profits for reinvesting purposes which is called retained earnings. After taking out, it becomes a part of income after adding to net income or if the statement gives net loss then it is also added to net loss.

Where retained earnings found under the balance sheet?

Basically, it increases the value of assets when retained earnings are included in cash and it decreases the value of liabilities when retained earnings are included in equity capital. RE recorded under shareholder’s equity section.

The shareholders invest shares in the firm in the expectation of getting major profit as a reward. The rewards are dividends, general profit but not retained earnings, it is emergency earnings that are invested in any kind of losses that cannot be covered only by a firm’s capital.

What retained earnings are usable for business?

Yes, of course. Retained earnings are the surplus funds for the business in bad financial condition. It’s not needed that all profits are distributed to shareholders, some of it is secured as additional funds for emergencies in business-like cover contingency losses, spending on expenses, investing on business projects, all these happen with the consent of shareholders with an expectation of more profits.

How are retained earnings beneficial?

  • Helps to enhance the business opportunities
  • Consider as a funds to cover debts
  • Maintain firm’s goodwill in worst situation
  • Spend on additional expenditures
  • Increases the income and reduces the liability
  • Easy source of collecting funds
  • Used in funding activities and investing activities

Can retained earnings give negative results?

In some cases, RE can put a negative impact on business such as:

Distributed cash and stock dividends always affect retained earnings by which the value of assets and cash decreases that put a negative impact on the balance sheet.

An increase and decrease in net income affect RE amount as well as the percentage of business profitability scale. It could be negative for a long time until the net income shows a positive balance after deducting dividends.

Net income, Revenue, operating expenses, cost of goods sold, and depreciation reduce the retained earnings at one time.

Is tax charged on retained earnings?

The IRS Tax is charged but not affected on investments. If the tax charger finds excess retained earnings then it is deducted as an IRS tax without taking justification from the firm.

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