The beginning period retained earnings is nothing but the previous year’s retained earnings, as appearing in the previous year’s balance sheet. The main difference between retained earnings and profits is that retained earnings subtract dividend payments from a company’s profit, whereas profits do not. Where profits may indicate that a company has positive net income, retained earnings may show that a company has a net loss depending on the amount of dividends it paid out to shareholders.
The truth is, retained earnings numbers vary from business to business—there’s no one-size-fits-all number you can aim for. That said, a realistic goal is to get your ratio as close to 100 percent as you can, taking into account the averages within your industry. From there, you simply aim to improve retained earnings from period-to-period. If you calculated along with us during the example above, you now know what your retained earnings are. Knowing financial amounts only means something when you know what they should be.
Factors Affecting the Size of Retained Earnings
Ending retained earnings is at the bottom of the statement of changes to retained earnings which is only assembled after net income (the “true” bottom line) has been determined. Retained earnings, on the other hand, are reported as a rolling total from the inception of the company. At the end of every year, the company’s net income gets rolled into retained earnings. Therefore, a single number of retained earnings could contain decades of historical value accumulated over a much longer reporting period.
In more practical terms, retained earnings are the profits your company has earned to date, less any dividends or other distributions paid to investors. Even if you don’t have any investors, it’s a valuable tool for understanding your business. For those recording accounting transactions in manual ledgers, you should be sure closing entries have been completed in order to properly calculate retained earnings. Those using accounting software will have their retained earnings balance calculated without the need for additional journal entries. Retained earnings can be used to pay additional dividends, finance business growth, invest in a new product line, or even pay back a loan. Most companies with a healthy retained earnings balance will try to strike the right combination of making shareholders happy while also financing business growth.