RETAINED EARNINGS DEFINITION BASIC INFORMATION AND TUTORIALS

What are retained earnings? How to know retained earnings?

Tutorials about retained earnings.

Retained earnings 
Profits of a business that have not been paid out to the owners or stockholders (as dividends) as of the balance sheet date.These earnings are reinvested in the business.

Every company, from its inception, develops a history of profits and losses. Profits add to retained earnings and losses reduce retained earnings. If a company has operated with overall profitability, it will have accumulated a substantial amount of earnings over time.

If it is a proprietorship (unincorporated, one owner) or a partnership (unincorporated, two or more owners), these earnings are usually taxable to the owner(s) immediately, so they are typically paid out to the owner(s) each year, as dividends or distributions of profits.

However, if the company is a corporation, its owners will not generally be taxed on the company’s accumulated profits until the company chooses to distribute those earnings to its owners in the form of cash dividends.

In the interim, the accumulated earnings not distributed to its owners are shown as, logically enough, retained earnings. Earnings are retained in the business for other reasons than just to avoid paying taxes on them, including enabling the business to retain cash for expansion or to purchase land, buildings, and equipment (fixed assets) to facilitate its operations.

The company may also be building a “war chest” to enable it to:

• Buy other companies
• Protect itself against a possible catastrophe
• Repurchase its own stock, when prices are low
• Ensure adequate working capital to run the business

Wonder Widget is a relatively new company, so its retained earnings are still low. Some companies actually have negative retained earnings, because they’ve lost more money than they’ve made over their existence. (This is the situation for most airlines.)

You can usually recognize this by the caption “Deficit in retained earnings.” This is usually a good clue that you might not want to buy their stock just yet, as they may not yet have figured out how to make money in their business. (This was a story heard frequently in recent years in the aftermath of the dot-com collapse of 2000-2001.)