Retained earnings

economic-dictionary

Retained earnings are the part of the dividends obtained by a company that are not distributed among its partners or shareholders.

The retained earnings correspond to the profits or dividends of the company that remain in the company, that is, they are not distributed among its partners or shareholders. Companies may decide to keep them to achieve various objectives such as internal growth.

Net profit

Objective of retained earnings

At the end of the year, companies usually take stock of the profits obtained during the year and make the decision to distribute them among their partners or, leave all or part of it to finance other objectives, among which are:

  • Finance growth.
  • Increase the number of workers.
  • Maintain a reserve fund in case of contingencies.

They can be a relevant source of financing that does not imply costs in bank interest and other related expenses (commissions, etc.). When used properly, they can increase the value of the business in the short term.

They are also considered as a measure of the value and stability of a company. A greater amount of retained earnings is a reflection that it has worked well over time and that it is likely that in the near future it will pay dividends to its partners or shareholders.

How Retained Earnings Are Calculated

They are calculated by subtracting expenses from income (thus obtaining net profit). Then, the dividends actually paid to the shareholders are subtracted. The remaining balance will be retained earnings.

Retained earnings cycle

When companies are new, they generally do not make a profit so their net earnings, as well as their retained earnings, are zero.

Later, when the company has reached further development, it will be able to generate profits that it will probably retain in order to finance its growth without continuing to borrow.

Then, when it has reached maturity, it can distribute part or all of its profits to its partners or shareholders.

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