Retained Earnings Definition and Formula
Retained Earnings Definition – “All after-tax income held by a business (and not paid out in dividends) since its inception”.
In simple words, it is the portion of profit that is kept aside by the company and not paid as dividend to the shareholders. Retained earnings is known by various names such as Accumulated earnings, earnings surplus or unappropriated profit.
It appears in the Balance Sheet under the head Shareholder’s equity. In addition to this, these earnings represent the past and present earnings of the firm that are reinvested in order to expand the organisation. Sometime, conflict may arise with respect to retained earnings in the organisation.
Investors likes to get dividend especially who are on their retiring age. When firms keep the amount of net profit with itself, it creates perception in the mind of investor that there is some structural problem going on in the enterprise. Plus it reduces the dividend that investors gets.
Retained Earnings Formula
Retained Earnings = Net Profit – Dividend
Related Financial Terms of Retained Earnings
- Return on Equity Definition – ROE Meaning and Importance
- Valuation Definition – Procedure and Importance
Importance of Retained Earnings
The most important thing to understand about the retained earning is that it is not the left over after providing for the dividends. Instead it is what company has done with the profit. In addition to this, retained earnings also reflects the dividend policy. As it tells whether organisation is providing the dividend or reinvesting it into the business.
Companies which are capital intensive like technology based firms or firm which are growing retain more and pay less. It is quite difficult to compare the companies on the basis of retained earnings. Therefore, it is also advisable to compare companies belonging to same sector or industry.