Retained Earnings

1. Definition

Retained Earnings (RE) represents the cumulative amount of net income that a company has kept (retained) inside the business rather than distributing it to shareholders as dividends.

It is reported under the Shareholders' Equity section of the Balance Sheet and serves as a primary source of internal financing for the company.

2. Formula

Retained Earnings is updated at the end of each accounting period using the following formula:

$$ \text{Ending RE} = \text{Beginning RE} + \text{Net Income} - \text{Dividends} $$

• Beginning RE: The balance carried over from the previous period.
• Net Income: The profit earned during the current period (from Income Statement).
• Dividends: Cash or stock distributed to shareholders.

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3. Primary Uses

Companies use these funds to generate value, rather than just holding them as cash.

• Reinvestment: Funding business expansion, such as buying new equipment, R&D, or acquiring other companies (M&A).
• Debt Repayment: Paying off existing loans to reduce interest expenses and improve the debt-to-equity ratio.
• Buffer: Acting as a financial cushion to absorb future losses during economic downturns.

4. Why It Matters

• Internal Growth Engine: High retained earnings indicate that a company can fund its own growth without relying on expensive debt or diluting ownership through new stock issuance.
• Indicator of Maturity: Mature, profitable companies typically have large retained earnings balances, while startups may have negative retained earnings (Accumulated Deficit).

5. Common Misconception

• Retained Earnings $\neq$ Cash Balance.
  • A high retained earnings figure does not mean the company has that amount of cash in the bank. The earnings have likely already been reinvested into assets like inventory, factories, or computers.
  • Therefore, a company can have high retained earnings but low liquidity (cash poor).