What are retained earnings and the statement of retained earnings?
Retained earnings are part of a company’s net earnings after taxes (net profits, net earnings) kept to accumulate, after dividends are paid. After a profitable period, a company can (at the discretion of its board of directors) pay some of its income to shareholders, as dividends, and keep the remainder as retained earnings. The company’s accumulated retained earnings appear on the Balance Sheet under owner’s equity.
In addition to the balance sheet appearance, retained earnings are declared each year on a statement of retained earnings. The statement of retained earnings is one of the four primary financial accounting reports published quarterly and annually by publicly held companies (companies that sell shares of stock to the public). The other three are the income statement, balance sheet, and statement of changes in financial position (SCFP).
The retained earnings statement is usually the briefest of these, often just a few lines, as the example statement below shows. However, from the owner shareholders point of view, the retained earning statement is arguably the most important of the four. Many people believe that the highest level objective for a for-profit company is "To increase owner value." Each period, this statement reports precisely how owner value has increased, through dividends paid directly to shareholders, and as retained earnings which increase owners equity.
Public companies (companies that sell shares of stock to the public) are required to publish a statement of retained earnings and the other primary financial statements in an Annual Report to Shareholders, which is sent to shareholders shortly before the company's annual meeting to elect directors. Annual reports with financial statements can also be found on the company's internet site, usually available through a page called "Investor Relations," or something similar.
Where do retained earnings come from?
For purposes of financial accounting, a profit making company can do only two things with profit earned: (1) distribute to shareholders (the company owners) as dividends or (2) keep some or all of the profits as retained earnings. Many companies divide profits for both uses each year.
The statement of retained earnings is sometimes described as a bridge between the Income statement and balance sheet. The statement shows how profits from the period (from the Income statement) are either transferred to the balance sheet, as retained earnings, or to the company's owners (shareholders) as dividends.
The basic statement of retained earnings equation is as follows:
Net income = Preferred stock dividends paid
+ Common stock dividends paid
+ Retained earnings
Retained earnings = Net income
– Preferred stock dividends paid
– Common stock dividends paid
Retained earnings, in other words, are the funds remaining from net income after dividends have been paid to the owners (shareholders). Each period's retained earnings are added to the cumulative total from previous periods, to create the current retained earnings balance.
Example statement of retained earnings
This example statement of retained earnings is from the same set of related company reporting statements used elsewhere in this encyclopedia, including an example income statement, balance sheet and statement of changes in financial position.
Example statement of retained earnings.
How do retained earnings impact other financial statements: Income statement, balance sheet, and cash flow statement (SCFP)?
The Statement of retained earnings is the shortest of the four primary financial accounting statements, but it provides the clearest illustration of the interrelated nature of these statements. Every entry in the example above also appears on another of the primary statements.
- The retained earnings beginning balance appears on the previous period's (end of period) balance sheet, under Owner's Equity.
- The net income figure is of course the bottom line, or net profit figure from the current period's income statement
- The dividend payments for preferred and common stock shareholders also appear on the current period's Statement of changes in financial position (SCFP, or cash flow statement), under Uses of Cash.
- The end of period retained earnings balance also appears on the current balance sheet (statement of financial position) under Owner's Equity.