Guide to Preparing a Statement of Retained Earnings
Investors and business owners alike care a lot about retained earnings.
But what are they?
In this article, we’ll explain what retained earnings are, what a statement of retained earnings shows you, and how to use those earnings to improve your business.
What Are Retained Earnings?
Retained earnings (also known as RE) are the leftover net income a business has after paying out the dividends it owes to its shareholders. Retained earnings can either be positive (known as profit) or negative (known as losses.)
Companies strive to turn a profit and usually either pay those profits out to shareholders, or they spend that money on additional employees and other forms of capital to help grow the business further. This can help them further capitalize on a good fiscal quarter to help further increase revenues down the line.
But your company needs a statement of retained earnings to really understand whether they’re operating at a profit or a loss.
What Is A Statement Of Retained Earnings?
A statement of retained earnings (also known as a retained earnings statement) is a financial statement that provides an overview of the changes in a company’s retained earnings over a specified period of time. Business leaders can use the information found on the statement of retained earnings to determine how positive or negative their earnings situation is and what they should do with them.
Statements of retained earnings are usually templated. In fact, you can find a lot of retained earnings statement templates online. But every version of the template adheres to the generally accepted accounting principles or GAAP. This document goes by other names as well such as a statement of equity, statement of shareholders’ equity, or an equity statement.
What Is Included In A Statement Of Retained Earnings?
Not all retained earnings statements are standalone documents. Sometimes they’re added to a company’s most recent balance sheet or income statement. But sometimes they’re not. Either way, the retained earnings statement usually includes information about the retained earnings, net income, and dividends distributed to stockholders.
The statement of retained earnings will also include information about what earnings will be used to cover losses in different company departments if necessary. So if one department was especially profitable in the last quarter, but another wasn’t as successful, the statement will explain how funds will shift to cover that one department’s losses with the other’s profits.
Why Is The Retained Earnings Statement Important?
So why would someone other than the CEO care about the earnings statement of retained earnings?
There’s an easy answer here.
The retained earnings statement tells shareholders how much equity they own in the company collectively. If you’re an investor, you’re probably most interested in knowing how much money you’re entitled to. And although investors only get paid when the company issues dividends, it’s always good to know how much your share of the company is worth should you decide to sell at any point in the future.
How Can You Use Retained Earnings?
The retained earnings mentioned on your statement can be used in multiple ways.
It can be used to pay additional dividends to investors, It can be used to help finance additional business growth. It can be reinvested in a new product line or service offering that can then generate additional revenue. Or it can be applied to one or more outstanding debts. Like, for example, if your business took out a business loan. This is a good idea because it will reduce the total number of months that that loan payment takes away from your monthly profits.
The point is, when reviewing your statement of retained earnings, you can use that money in multiple ways.
The Payout Ratio Vs The Retention Ratio
There are two ratios that are part of your statement of retained earnings.
There’s the Payout ratio and the retention ratio.
The payout ratio is a ratio that explains what portion of your retained earnings are going towards investors in the form of dividends. This number is what helps investors know what exactly they can expect to make from their investment.
The retention ratio is essentially the opposite of the payout ratio. That means it’s telling investors how much of the retained earnings will be reabsorbed by the company to build, improve, innovate business practices, or paying off debts.
These ratios are opposites of each other. So if the payout ratio is 30% (3:10) then the retention ratio is going to be 70% (7:10.)
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All you do is enter your info, preview your paystub, complete your order, and print the stubs.
And just like that, you’re able to pay your employees for the work they’ve done that has helped you keep your retained earnings positive.
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