How To Calculate Retained Earnings?
Retained Earnings (RE) is a measure of profitability that helps investors evaluate the performance of companies over time. The calculation involves adding net income or profit before taxes to capital expenditures.
Retained Earnings are calculated by subtracting total depreciation from total assets. This number represents the amount of cash flow generated by the company after deducting the cost of building its assets.
Retained Earnings are useful because it allows investors to compare the financial health of a company over time. For example, if a company has $100 million in sales and $50 million in retained earnings, then it means that the company has $50 million in profits.
The concept of Retained Earnings is a valuable one in the world of accounting. As mentioned above, using the Retained Earnings formula to calculate a company's historic profits helps accountants and investors get an idea of a company's viability and financial stability.
In this article, we'll be discussing the formula used to calculate Retained Earnings, along with a worked example, and some key concepts to think about when looking at Retained Earnings.
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The Formula For Calculating Retained Earnings
The formula for calculating Retained Earnings is as follows:
Current Retained Earnings + Profit/Loss - Dividends = Retained Earnings
Or in other words:
BP + Net Income/Loss - C - S = RE
BP = Beginning Period Retained Earnings
C = Cash Dividends
S = Stock Dividends
Most accounting software companies or even Microsoft Excel can do this calculation for you when it comes to running your company's balance sheet or other financial statements.
However, if you ever need to do this calculation manually, you'll need the following three variables as detailed in the second example of the Retained Earnings formula above.
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Beginning Period Retained Earnings
This is typically whatever the company's retained earnings were the last time it was calculated.
You should be able to find this on the income statement generated in the current accounting period.
Put simply, these are company profits in the form of cash or stock which has been taken out of the company by yourself or shareholders.
Now that we've got the formula, let's take a look at a simple worked example.
Let's say, for argument's sake, that you started a company on January 1st with $1,000.
If you calculate your retained earnings on January 1st, you should expect it to be $1,000.
By the end of January, you have earned $1,000 in net income and don't issue any dividends to shareholders.
This means that on February 1st your retained earnings will be $2,000 because:
Current Retained Earnings ($1,000) + Net Income ($1,000) - Dividends ($0) = Retained Earnings ($2,000)
Key Concepts When Looking At Retained Earnings
When looking at a company's historical Retained Earnings, there are several important things to keep in mind.
First, most companies will have a positive beginning period of Retained Earnings. This means that they had more money than they spent during their first year of operations. If they didn't, then that would mean that they lost money. So, this is good news! It shows that the company is profitable.
Second, dividends paid out to shareholders can also affect how much Retained Earnings you see.
If a company pays out dividends, then those dividends will show up as part of the net income figure on the income statement.
If the company doesn't pay dividends, then the company won't have any cash coming into the company. Instead, the company will receive shares of stock from shareholders. Those shares of stock will appear as part of the total number of shares outstanding on the Balance Sheet.
Third, the amount of cash received by a company through stock dividends may vary depending on the type of dividend being given out. Some companies give out regular dividends while others give out special dividends.
Regular dividends are usually what you'd expect to see. Special dividends are not always easy to predict. They're often given out when the company needs additional cash to fund something like a new product launch.
Fourth, the amount of cash paid out to shareholders through stock dividends may also vary based on the type of dividend. Some companies give out ordinary dividends while others give out preferred dividends. Preferred dividends are generally considered to be higher quality than ordinary dividends because they come with some sort of preference over common shareholders.
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The Difference Between Revenue And Retained Earnings
Retained Earnings are a measure of profit left after all costs have been accounted for.
Revenue is a measure of sales. Sales include revenue from products sold, services provided, and other items such as royalties.
It's important to note that revenue does not necessarily equal profit. For instance, if a company sells products at a loss, then its revenue will still be greater than zero. However, its profits will be negative.
A company's retained earnings are different from its net income. Net income measures the difference between revenues and expenses. The retained earnings measure the difference between revenues and operating expenses.
In addition, companies can lose money even though they have a large amount of retained earnings. This tends to happen when a company has high levels of debt.
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Are There Any Limitations Of Retained Earnings?
If you're examining the definitive figure of retained earnings for a company in a specific financial quarter or year, this might provide an accurate insight into the company's financial health.
This means that, yes, there are limitations of retained earnings, as looking at it for a short period of time up to a year won't show you the whole picture.
By looking at retained earnings over a longer period of time, (say five years) indicates any trends regarding how much money the company is adding to retained earnings.
When calculating retained earnings, keep in mind that it's not just about the current numbers. It's also about the future.
Retained earnings can tell us whether a company is making enough money to sustain itself going forward.
However, it's important to remember that retained earnings don't tell us everything we need to know about a company.
For example, it's possible for a company to make lots of money but still have low levels of retained earnings.
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