A company declares its dividend based on the profit that the company earns after paying for all statutory liabilities. But most of the time, the full amount of profit is not distributed by way of dividend. The portion of the profit that is retained or kept with the company is termed as retained earnings. The retained earnings component is shown as “shareholders-equity” on the balance sheet of the company. At terms, in daily communication, it is also referred to as plowback.
The earnings that are retained may be used for various purposes. Some of the common ones are :
- Reinvestment in the same company
- Modernisation or expansion plans
- Pay off debt
- Procurement of new machinery or technology
- Investing in research orientated programs
- Branding or Trademark related investment
At times, in the balance sheet , an organisation may even report “negative retained earnings”, which will signify that there is a deficit in the company’s account. It may also be termed as “positive shareholder’s deficit”. Any transactions in the retained earnings component should be adjusted as income or expense as per the nature of transactions. It should be noted that this amount is not the surplus to any company, it is in fact a way in which a company handles its profits.
It’s nice to know these financial terms in a clear and concise way when you’re investing in company shares, or when you’re starting a business of your own. Retained earnings is one of those things that you hear spoken about a lot, but never truly understand. Thanks for the clarification!
Sreya has explained ‘retained earnings’ very well and lucidly. I have come across this term for the first time. But, I realize it is a very important part in business. I think in layman’s words it could be explained as the amount put aside as savings from one’s monthly salary for a certain purpose. A very informative article.
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