What are Retained Earnings?
Retained earnings are the portion of a company's profits that are not distributed to shareholders as dividends, but are instead kept by the company to be reinvested in the business or used to pay off debt. Retained earnings represent the accumulation of profits over time and can be used to fund a variety of business activities, such as research and development, capital expenditures, and working capital.
Retained earnings are recorded on a company's balance sheet under the equity section. They are calculated by subtracting dividends paid to shareholders from net income. For example, if a company has a net income of $100,000 and pays dividends of $50,000 to shareholders, its retained earnings would be $50,000.
Retained earnings can also be negative, which is known as a retained earnings deficit. This occurs when a company has consistently incurred losses or has paid out more in dividends than it has earned in profits. A retained earnings deficit can be a sign of financial distress and may indicate that the company is unable to generate sufficient profits to fund its operations or pay off its debts.
In general, retained earnings are an important source of capital for businesses, as they provide a way for companies to finance growth and expansion without having to rely on external sources of funding. However, if a company's retained earnings become too large, it may be seen as hoarding profits and not returning enough value to its shareholders. In these cases, investors may pressure the company to pay out a larger portion of its profits in the form of dividends.