Retained Earnings

What are retained earnings?

Retained earnings is the amount of net income kept by the corporation rather than distributed as dividends over the history of the company.

How can retained earnings be calculated?

A particular accounting period’s retained earnings can be calculated as:

Retained Earnings = Net Income - Dividends

Retained earnings are technically cumulative from quarter to quarter and a company’s total retained earnings are reported on its balance sheet under shareholder’s equity. This cumulative retained earnings figure can be calculated by summing the individual retained earnings, calculated with the above formula, from every period in the company’s history.

Is it possible to have negative retained earnings?

Yes, retained earnings can be negative over the history of the company as well as in any given accounting period. When negative, retained earnings are often called “retained losses.”

How is the retention ratio related to retained earnings?

The retention ratio is simply the ratio of retained earnings to net income. A higher retention ratio indicates that more money is being put into the business rather than being paid out as dividends. The retention ratio is also called the “retention rate” and the “plowback ratio.”

How is the retention ratio calculated?

It is calculated by subtracting dividends from net income, thus calculating retained earnings, and dividing this figure by net income.

• Retention Ratio = (Net Income - Dividends) / Net Income

For instance, if net income is $10 million and dividends are $5 million, the retention ratio is 0.5 [ ($10 million - $5 million) / $10 million = 0.5].