Retained earnings are defined as earnings that are hold back with the companies after distributing the relevant share of dividend to the shareholders. These earnings are holdings from the net income but or not included in the total profit of the company whereas these retained earning or hold back earnings are kept for future security where this secured amount is used as investment for future growth of the company or to realize the loans or debts of the company. Retained earnings are not kept as personal profit of one share holder but is used to invest.
All the amount hold back with the company from the net income after realization of the dividend to the shareholders i.e. retained earning is not hidden from the shareholders as all the transaction of the company should be open to every shareholder even he has invested in small proportion of the company. It is clearly mentioned in the balance sheet of the company that it has retained certain amount for future investment or to clear certain debts. You can find retained earnings under shareholders equity section of the balance sheet. Sometimes company uses separate report to inform the shareholders about retained earnings.
Where the company is habitual to bear losses these earnings are classified as retained losses.
How these retained earnings are reinvested?
The concept of retained earnings is not new to the world some called it savings and others call it extra cash holding for future investment. The company always look for some who can invest in their company for growth. Therefore, it is good that company already hold certain amount with themselves so they don’t have to look for investors to invest for every single task they pursue.
The company can use these retained earnings for running research and development programs of new product. This new product may change the face of the company. The boards of directors are the heads who lead the matters regarding retained earnings as they have to decide between different factors i.e. dividend to be distributed, tax to be paid, amount needed for expansion and amount for reinvestment.
How are these retained earnings important?
- Retained earning are used as a sign of financial growth in a company.
- The shareholders are always excited about the retained earnings of the company. They take these earnings very seriously because it is a sign that they have invested in right company
- These retained earnings are used to raise stocks and sales ultimately which a sign of growth over all to a company.
- If the company is incurring regular losses, it’s very obvious that the company has wrongly invested.
Why retained earnings are not an asset?
Assets or something that are permanent earnings. Retained earnings may be regarded as extra profits but are not permanent to the company as they are kept aside to realize future loans or to invest again for the betterment and growth of the company. These earnings are used to buy new product or stalking up for raising sales.
Retained earnings are always considered as credit transaction for the company until and unless these are retained losses.
Retained earnings are not considered as assets in itself but are used to buy future assets for the company or to realize the past loans or liabilities. It is not sometime possible to keep entire retained earnings inform of hard cash.
As explained before that retained earnings are the earnings that are hold back after distributing the dividend to the shareholders. Thus, these retained earnings are not amounted to tax. The dividend is always distributed after paying the tax.
What are the points to be remembered while evaluating the amount of retained earnings?
1. Age of Company
As we all know “old is gold” and gold holds the higher value in the market. Similarly, retained earnings higher where the company is old.
2. Dividend Policy
The amount of retained earning a company holds it’s totally depend upon the dividend policy adopted by the company as the amount is retained from the dividend only and it is wrong to dissatisfied the shareholders as it is there right to get right share in the companies profit they have invested.
The retained earning of the company is dependent upon the profit margin a company holds. It does not promise that company surely retained earnings if it generates more revenue because it’s not compulsory that higher the revenue, higher the profit. As sometimes people generate more revenue by selling out product on same rate it’s bought to clear stock. Thus, profit margin plays a great role in holding retained earnings.
I hope this article has helped you understand the concept of retained earning and not you don’t confuse it with assets or personal belongings. It’s open and clear to all shareholders of the company.