When a business earns a surplus income, it can either distribute the surplus as dividends to shareholders or reinvest the balance as retained earnings. You’ll want to find the financial statements section of a company’s annual report in order to find a company’s retained earnings balance and all the supporting figures you’ll need retained earnings on balance sheet to complete the calculation. 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.
If you run a seasonal business, like a snow removal company, your retained earnings will likely vary across quarters. But the retained earnings of a year-round business like a car shop will be more constant. Depreciation – Depreciation can reduce net income, and therefore earnings retained, if a fixed asset’s cost is spread out over its useful lifespan. For our retained earnings modeling exercise, the following assumptions will be used for our hypothetical company as of the last twelve months (LTM), or Year 0. There are numerous factors that must be taken into consideration to accurately interpret a company’s historical retained earnings.
How to Interpret Retained Earnings?
As we’ve discussed, startups are generally expected to accumulate a deficit, and even if a startup is able to generate net income, it’s unlikely to pay dividends. The focus is on scaling their businesses, so retained earnings aren’t a major priority. Put simply, negative retained earnings aren’t a major concern for new companies as they’re likely using that money for operating expenses and reinvestment into the business.
The screenshot below is the income statement of Apple (AAPL) for the fiscal year ending 2022. The dotted red line in the shareholders’ equity section of the balance sheet is where the retained earnings line item can be found. Retained Earnings are the portion of a business’s profits that are not given out as dividends to shareholders but instead reserved for reinvestment back into the business. These funds are normally used for working capital and fixed asset purchases or allotted for paying of debt obligations. One way to assess how successful a company is in using retained money is to look at a key factor called retained earnings to market value. It is calculated over a period of time (usually a couple of years) and assesses the change in stock price against the net earnings retained by the company.
Example Retained Earnings Calculations
A maturing company may not have many options or high-return projects for which to use the surplus cash, and it may prefer handing out dividends. Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent. At the end of the current year, the company has $1,550,000 of retained earnings on hand.