The financial accounting term retained earnings is used to describe the portion of net income that is not distributed to common or preferred stockholders in the form of dividends, and is held by the company for future use. Retained earnings appear in the owner’s equity section of the company’s balance sheet.
Retained Earnings = Net Income – Dividends Paid to Shareholders
Also known as retained surplus, retained earnings is one of several subsections appearing in the owner’s equity section of the balance sheet. The other subsections include preferred, common and treasury stock. Owner’s equity includes the original capital investments made by shareholders plus those profits retained by the company; that is to say, not returned to shareholders in the form of dividends.
Companies choose to retain earnings for several reasons. The money can be invested in new machinery, equipment, or research with the hope of generating additional profits. Alternatively, the money can be used to lower the amount of debt issued by the company; thereby reducing the use of leverage.
If a company does not operate profitably, there can be what is referred to as a retained loss or deficit.
Company A’s income statement indicates net income of $4,283,000, while the company’s cash flow statement indicates dividend payments of $1,555,000. The increase to retained earnings for Company A would be:
= $4,283,000 – $1,555,000, or $2,728,000