As an investor, knowing terms related to the investment world is essential as it helps you understand what companies are up to. One such word is the Retained Earning Formula. The term is used predominantly in the investment world and carries a lot of weight.
For those who don’t know the term, this post will discuss Retained Earning Formula and what you need to know about it.
What Is Retained Earnings?
Retained Earnings (RE) refers to the amount of net income remaining for a company after it has paid out dividends to its shareholders. In general, companies generate either positive or negative earnings.
When they generate positive earnings, they have the opportunity to utilize the surplus money. In most cases, companies share the funds to shareholders or use it for growth. The funds not paid to shareholders is usually regarded as retained earnings.
Retained Earnings Formula
To calculate the Retained Earnings of a company, use this formula:
RE= BP+ Net Income (or Loss) −C−S
In this case;
BP stands for Beginning Period RE
C stands for Cash dividends
S stands for Stock dividends
In full, the formula goes like this:
Retained Earnings = Beginning Period RE + Net Income/Loss – Cash Dividends – Stock Dividends
The Retained Earnings Formula is a calculation that obtains the balance in the RE account as the end of a reporting period. The RE is usually converted to working capital, an asset for the company, or used to pay down outstanding liabilities by the company.
What Retained Earnings Means for Investors
In a scenario, a company generates excess income, some long-term investors of the company could expect regular income in the form of dividends. This is their reward for investing in the company. For short-term traders, they might get dividends that will offer instant gains.
When companies share excess income, they usually do so with dividends. This is because dividends are tax-free income in most jurisdictions, while profits on stocks are subject to taxes. However, the company can decide that it has better use for the excess money.
Usually, in this case, the management reinvests the excess funds and pay higher dividends to shareholders in the future.
Different Ways To Use RE
The surplus money from a company can be utilized in various ways.
- The funds will be shared amongst shareholders as a reward in the form of dividends.
- It can be used to expand the operations of the company to boost growth. This is the most likely situation for most companies
- The funds can be used to launch a new product or start a new line of service
- It could be used for any possible acquisition, merger, or partnership to boost the business prospects of the company
- The funds can be used to buy back shares of the company
- The excess income can also be used to settle any outstanding loan the company might have.
What Happens To Profits
Management decides what to do with retained earnings. They can choose to pay investors through a dividend, reinvest it into the company, or settle debts.
Executive leadership usually allocates these funds because they have a better knowledge of the market. However, sometimes shareholders have the opportunity to vote on the matter.
In most cases, the management of a company takes a balanced approach. They pay investors a certain amount as dividends while the remaining Retained Earnings are used to boost the growth of the company.
Retained Earnings Formula: Final Thoughts
The Retained Earning Formula is a crucial term for investors to know as it allows them to keep track of company activities. If you’re ready to know more about Retained Earnings Formula and more, you should sign up for Stock Dork Alerts. We provide a steady stream of stock market news and analysis that will help keep you informed on everything happening in the world of Wall Street. Plus, our reports are written in plain English, so they’re easy to understand. After just a few weeks reading Dork Alerts, you’ll sound like the smartest guy at the water cooler. Sign up today and get a jump on the New Year with our 2020 Growth Stock Guide, it’s yours free when you join. Click here to join and claim your free copy now.