Retained Earnings

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Retained Earnings is the portion of net income that the company does not distribute to its shareholders as dividends

Retained earnings appear on a company's balance sheet and are accumulated from one year to the next. When accumulated retained earnings is negative, it is called retained losses (also known as accumulated losses, or accumulated deficit). Retained earnings are calculated by adding net income and subtracting dividends from last year's retained earnings.

Ending retained earnings = Beginning retained earnings + net income - dividends

When looked at in conjunction with net income, retained earnings is used as an indicator of the company's priorities vis-a-vis paying its shareholders or bringing that money with it into its next fiscal period.

Fluctuations in retained earnings may be an indicator of a company's expectations for upcoming fiscal period: if a company's retained earnings increase dramatically one year or quarter, it may be indicative of a pessimistic outlook for the upcoming fiscal period. By contrast, if retained earnings decrease, the company is paying its shareholders a hefty dividend and is therefore likely optimistic about future earnings.

Example

Suppose a company begins business on 20X1 and has net income of $50 million. It does not pay any dividends. Then its retained earnings for the year would be $50 million (0+50-0). In 20X2, the company earns $40 million and pays $10 million in dividends. Its retained earnings for the end of the year would be $80 million (50+40-10). In 20X3, the company makes a loss of $100 million and pays no dividends; at the end of 20X3, the company's accumulated deficit (since retained earnings is negative) would be $20 million (80-100).

Equation

The retained earnings account on the balance sheet is said to represent an "accumulation of earnings" since net profits and losses are added/subtracted from the account from period to period.

The general equation can be expressed as following:

Ending Retained Earnings = Beginning Retained Earnings - Dividends Paid + Net Income

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