Introduction
Earnings Retained, commonly referred to as Retained Earnings, represent the portion of a company’s profits that is held back in the business after dividends have been distributed to shareholders. These retained earnings are reinvested in the business for various purposes, such as expansion, debt reduction, or other operational needs.
Historical Context
The concept of retained earnings dates back to the early development of corporate finance, where businesses realized the importance of reinvesting profits to sustain growth and improve financial stability. Historically, the accumulation of retained earnings has played a crucial role in the development of major corporations and their ability to withstand economic downturns.
Types/Categories
- Distributable Retained Earnings: Profits available for distribution to shareholders after meeting regulatory requirements and capital needs.
- Non-distributable Retained Earnings: Profits that are reinvested into the company for expansion, research, and development, and are not available for distribution.
Key Events
- 1930s Great Depression: Many companies relied on retained earnings to survive during the economic downturn.
- Post-World War II Expansion: Businesses used retained earnings extensively for rebuilding and expansion.
- 2008 Financial Crisis: Companies with substantial retained earnings were better positioned to navigate the crisis.
Detailed Explanations
Retained earnings are recorded on the balance sheet under shareholders’ equity. The formula to calculate retained earnings is:
Retained Earnings (RE) = Beginning RE + Net Income - Dividends
This can be visualized through the following formula:
graph LR
A[Beginning Retained Earnings] --> B[+ Net Income] --> C[- Dividends]
C --> D[Ending Retained Earnings]
Importance and Applicability
Retained earnings are essential for:
- Business Growth: Funding expansion and investment in new projects.
- Financial Stability: Providing a buffer against economic uncertainties.
- Creditworthiness: Enhancing the company’s credit profile by showcasing strong equity.
Examples
- Tech Startups: Companies like Amazon reinvest a significant portion of their earnings into R&D, leading to sustained innovation and growth.
- Manufacturing Firms: Use retained earnings for upgrading equipment and expanding production capacity.
Considerations
- Dividend Policy: Companies must balance between paying dividends and retaining earnings.
- Investment Opportunities: Effective utilization of retained earnings in profitable projects.
Related Terms
- Dividends: Payments made to shareholders from a company’s profits.
- Net Income: The profit of a company after all expenses and taxes have been deducted.
- Shareholders’ Equity: The residual interest in the assets of the entity after deducting liabilities.
Comparisons
- Retained Earnings vs. Dividends: Retained earnings are reinvested in the company, while dividends are distributed to shareholders.
- Retained Earnings vs. Reserves: Reserves are a portion of retained earnings set aside for specific purposes like contingency funds.
Interesting Facts
- Warren Buffet’s Berkshire Hathaway has a policy of retaining almost all of its earnings.
- Historically, companies with high retained earnings have shown better resilience during economic downturns.
Inspirational Stories
Apple Inc.: From near bankruptcy in the late 1990s, Apple effectively utilized retained earnings to invest in innovation, leading to the launch of iconic products like the iPhone, which transformed it into a trillion-dollar company.
Famous Quotes
- “Do not save what is left after spending, but spend what is left after saving.” - Warren Buffett
- “Earnings retained within the firm provide a greater source of funds for expansion.” - Philip Fisher
Proverbs and Clichés
- “A penny saved is a penny earned.”
- “Save for a rainy day.”
Expressions, Jargon, and Slang
- Plowback Ratio: The percentage of earnings retained in the business.
- Self-financing: Using retained earnings for business activities rather than external funding.
FAQs
Why are retained earnings important for a company?
How do retained earnings impact shareholders?
References
- Brealey, R. A., Myers, S. C., & Allen, F. (2011). Principles of Corporate Finance. McGraw-Hill/Irwin.
- Graham, B., & Dodd, D. L. (2009). Security Analysis. McGraw-Hill Education.
Final Summary
Earnings Retained, or Retained Earnings, are crucial for the sustainable growth and financial health of a company. By understanding the importance and effective utilization of retained earnings, businesses can ensure long-term stability and value creation for shareholders. This article covered the historical context, calculations, importance, and examples to provide a comprehensive understanding of the term.
