Retained earnings are a continuous count of how much profit your firm has managed to keep from its inception. They rise whenever your firm makes a profit and fall if you distribute part of those gains as dividends. The process to Calculate Retained Earnings (RE) is the cumulative portion of a company’s profits that aren’t paid as dividends to shareholders and are instead set aside for reinvestment. These funds are often utilized for working capital and fixed asset acquisitions (capital expenditures) or for debt repayment.
After each accounting period, retained earnings are recorded on the balance sheet under the shareholder’s equity section. To calculate RE, add the initial RE balance to the net income, deduct the net loss, and subtract dividend distributions.
What Is the Point of Having Retained Earnings?
The retained profits serve a very helpful connection because retained profits are reported under shareholders’ equity. You will see that this in fact links the two statements. You can also use the retaining earnings for a variety of purposes, such as purchasing new equipment and machinery, investing in research and development, or engaging in other activities that could produce growth for the firm. These investments in the firm intend to generate even higher profits in the future.
Formula & Steps of How to Calculate Retained Earnings
The formula for calculating retained earnings is quite simple:
Retained Earnings = Current Retained Earnings + Profit/Loss – Dividends
When your accounting software creates your company’s balance sheet, statement of retained earnings, and other financial statements, it will perform this computation for you. However, if you are manually computing retained earnings, you must first determine the following three variables before entering them into the calculation above.
Your current or starting retained earnings, which is just whatever your retained earnings balance was when you last computed it. (For example, if you make a monthly balance sheet, you’ll utilize the previous month’s retained earnings.)
Your net profit/loss will most likely be derived from the income statement for the current fiscal period. If you create them monthly, for example, utilize this month’s net profit or loss. (For further information on calculating net income, see this page.)
An Example of Calculating Retained Profits
- Assume your company began operations on January 1, 2021. Because you have no profits to keep, your retained earnings account will be $0 on January 1, 2021.
- Let’s assume you generate $1,000 in net income (from your income statement) in January and don’t pay out any dividends.
- That means your company’s retained earnings will be $1,000 on February 1.
- Current retained earnings minus net income minus dividends equals retained earnings.
- $1,000 = $0 + $1,000 – $1,000
- This makes sense: you made $1,000 in earnings and kept them all.
Calculate Retained Earnings at the End of the Period
You may compute your final Retained Earnings balance for the balance sheet at the end of the period by taking the starting period, adding any net income or net loss, and deducting any dividends.
How to Figure Out How Much a Stock Dividend Will Cost You in Retained Earnings?
When a corporation wants to reward its shareholders with a dividend but doesn’t want to give away any cash, it can issue a stock dividend.
- To figure out the exact amount of dividends you’ll be distributing, you’ll need to take a few more procedures after a stock distribution.
- To begin, determine the fair market value (FMV) of the shares you’ll be distributing.
- The formula for retained earnings in a stock dividend is as follows:
Retained profits = Current retained earnings + Net income – (number of shares x FMV of each share)
Calculation of a Stock Dividend Example
- Let’s assume your firm is still booming in March, and you generate another $10,000 profit. You decide to issue a 5% stock dividend rather than a cash dividend because you want to preserve that money for reinvestment in the firm.
- Let’s assume your firm has 10,000 outstanding shares of common stock, and you estimate that each share is worth $10 at fair market value. As a result, you’d issue 500 dividend shares, each of which would reduce retained earnings by $10:
- Retained profits = Current retained earnings + Net income – (number of shares x FMV of each share)
- $14,000 = $9,000 + $10,000 – (500 x $10)
Working Capital & Shareholder’s Equity
- Working capital and shareholder’s equity (also known as stockholder equity, paid-in capital, or owner’s equity) are not the same as retained earnings, even though they all belong in the equity part of the balance sheet.
- Shareholders’ equity is a measure of how much your firm would be valued if all of its assets were liquidated. The following is the formula for calculating it:
- Total Assets minus Total Liabilities Equals Shareholders’ Equity
- Working capital is a measurement of the resources available to your small business to support day-to-day operations. Subtract all of your existing obligations from your current assets to obtain it:
- Current Assets minus Current Liabilities equals Working Capital.
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