With this retained earnings calculator, you can easily calculate how much money a company has left to reinvest into its business. Retained earnings is useful when analyzing the financial health of the company. It is also an important metric to analyze its growth opportunities, since a company needs to reinvest the money to grow.

We have written this article to help you understand what retained earnings is and how to calculate it using the retained earnings formula. We are also determined to help you understand the retained earnings definition and concept by showing you some examples.

What is retained earnings? – Retained earnings definition

Retained earnings means the amount of net income left after the company has distributed dividends to its common shareholders. The retained earnings can act as a metric for analyzing a company's financial health because it is the money leftover after all the direct and indirect costs are deducted.

Besides analyzing a company's financial health, the retained earnings are also a good measure for the company's growth prospects. This is because the retained earnings are equivalent to the amount of money the company can reinvest into the business. Under normal circumstances, the more money that is reinvested, the more a company can grow.

So, how can we calculate such an important metric? Check the following retained earnings example.

How to calculate retained earnings?

Let's use Company Alpha as an example to understand how to find retained earnings, assuming Company Alpha has the following numbers:

There are 4 steps in applying the retained earnings equation:

  1. Determine the net income or earnings.

To obtain the net income or earnings, it is recommended that you check the company's annual report. This information is usually included in the income statement of the company.

For our retained earnings example, the earnings for Company Alpha is $1,000,000.

  1. Determine the dividends distributed.

The dividends distributed by the company can be calculated using the formula below:

dividends distributed = earnings * dividend payout ratio

Hence, the dividends distributed by Company Alpha is $1,000,000 * 30% = $300,000.

  1. Calculate the retained earnings.

Now, let's calculate the retained earnings itself. We can do this using the retained earnings formula:

retained earnings = earnings - dividends distributed

According to the retained earnings equation, Company Alpha's retained earnings is $1,000,000 - $300,000 = $700,000.

  1. Calculate retained earnings per share.

To compare the retained earnings of different companies, it is useful to calculate retained earnings per share.

retained earnings per share = retained earnings / number of shares outstanding

Thus, the retained earnings per share for Company Alpha is $700,000 / 500,000 = $1.40.

So, you now know how to find retained earnings, let's learn more about this metric.

What are the limitations of the retained earnings?

There are, however, a few limitations of retained earnings that we need to be aware of.

Retained earnings can be very volatile sometimes, as dividend distribution is often at the discretion of the company's management. Although most mature companies enforce a stable dividend policy, most companies have their directors dictate how much in dividend payments to distribute and how much money to reinvest.

Secondly, it is vital to understand that higher retained earnings does not necessarily mean it is good for a company. Although the higher the retained earnings means more money can be reinvested back into growing the business, sometimes companies might reinvest more than they should. This happens when the company does not have enough profitable growth opportunities to pursue. Hence, it is important to check the PVGO (present value of growth opportunities) of the company before forming the dividend policy.

FAQ

What is the net income of a business?

Net income is the accounting income of a company after deducting the cost of operating its business and its cost of debt. Net income can also be called the earnings of the business. It is one of the most important metrics to assess a business.

What are dividends?

Dividends are the money a company distributes to its common shareholders. When a company has some earnings surplus, it can choose to give a portion back to its common shareholder in a form of dividends.

Can retained earnings be negative?

Yes, retained earnings can be negative, however counterintuitive it might sound. A company can still give out dividends even though it has negative net income by borrowing money.

What is a good retained earnings figure?

Most of the time, the higher the retained earnings the better, since it means that more money can be reinvested into the business. However, sometimes a company might not realize that they do not have enough profitable growth opportunities. Hence, reinvesting more money into the business might decrease shareholder value.

Wei Bin Loo
Dividends distributed
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Dividend payout ratio
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Dividends distributed
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Retained earnings
Retained earnings
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