Retained Earnings – The most important Long Term Source of Finance

Retained Earnings!! The term even though not so commonly used like Assets and Liabilities, is an important concept in Accounting. Do you know what retained earnings are? How is it helpful in business decision making? How does it impact the financial statements? The questions could be many. Read below to find out the answers.

 

Retained earnings are an important part of any business’s financial picture. Retained earnings refers to the money a company has earned and not used for paying expenses or dividends. In other words, Retained earnings refer to the percentage of net earnings not paid out as dividends, but retained by the company to be reinvested in its core business, or to pay debt. It is recorded under shareholders’ equity on the balance sheet.

 

Net income or loss is ascertained with the help of preparation of Income Statement also called as Trading, Profit & Loss Account. Retained earnings increase when a business receives income, whether through profits gained by providing customers a service or a product. Retained earnings are carried over from the previous year if they are not exhausted and continue to be added to retained earnings statements in the future. An increase or decrease in accumulated retained earnings during an accounting period is the direct result of the amounts of net income or loss and dividend payouts for that period.

 

Dividends also affect Retained Earnings. Dividends are paid to the shareholders as a return on their investment. This cash is paid out by the company to its stockholders on a date declared by the business’s board of directors, but only if the company has sufficient retained earnings to make the dividend payments. The Retained earnings and equity are both decreased as a result of paying dividends.

 

During an accounting period the Retained Earning may either increase or decrease due to the  fluctuations in a business’s cash flow which is mainly because of net gains or net losses or paying out dividends. All these events will be recorded in the Accounting records.
A large retained earnings balance always implies a financially healthy organisation.
 

 

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FAME is a leading Accountancy training provider. FAME brings together under one roof a wide range of accounting courses blended with real world experience and practical application. FAME aims to bridge the gap between theoretical knowledge and practical challenges that accountants face in their day to day working. We provide practical workplace skills for finance staff meeting the needs of employers, bankers, government and learners, both now and in the future. Our students are integral to the success of an organisation and at the heart of ensuring the smooth running of an accounting department.