Formula to Calculate Retained Earnings
Retained Earnings formula calculates cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company and it is calculated by subtracting the cash dividends and stock dividends from the sum of beginning period retained earnings and the cumulative net income earned.
Where,
- Beginning Period RE can be found in the Balance sheet under shareholders’ equity
- Net Income / (Loss) can be taken from Profit and Loss Statement
- Cash Dividend if paid any can be figured out from financing activity from cash flow statement
Explanation
Retained Earnings is very important as it reports how the company is growing with respect to its profit.
- An investor can make an idea through trend analysis whether the company is retaining its profit or its paying part of profits as dividends.
- As per the equation of Retained earnings is dependent upon previous year figure.
- The figure may be positive or negative depending upon inputs in the formula. If the company suffered a loss last year then it’s beginning period RE will start with negative.
- Similar to the second input is current year profit or loss which may be positive or negative depending upon how the company performed.
- In case a company is a dividend-paying company and hence even this could lead to a negative retained earnings if the dividends paid is large.
Examples
Example #1
Below given is the financial statement extract from ABC company. Do the Calculation of the Retained Earnings using the given financial statements.
- Beginning Period Retained Earnings = $0
- Net Income from the Income Statement = $70,000
- Cash Dividend = $5,000
So, we have gathered the following data for the calculation of Retained Earnings Equation.
So, the calculation of Retained Earnings equation will be as follows –
Retained Earnings will be-
Therefore, Retained Earnings =65000
Example #2 – Colgate
Let us now calculate the retained earnings of Colgate using the formula that we learned earlier.
Below is the snapshot of shareholders’ equity items of Colgate.
Retained Earnings at the beginning period = $18.861 million
Below is the snapshot of Colgate’s Income Statement.
We note that Colgate’s Net Income is $2,441 million.
We also note that Colgate’s Dividends were $1380 during the period.
- Ending Retained Earnings formula (2016) = Retained Earnings (2015) + Net Income (2016) – Dividends (2016)
- Ending Retained Earnings formula = 18,861 + 2441 – 1380 = $19,922 million
Calculator
You can use the following Retained Earnings Calculator-
| Beginning Period RE | |
| Net Income (Loss) | |
| Cash Dividend | |
| Stock Dividend | |
| Retained Earnings Formula = | |
| Retained Earnings Formula = | Beginning Period RE + Net Income (Loss) − Cash Dividend − Stock Dividend | |
| 0 + 0 − 0 − 0 = | 0 |
Use and Relevance of Retained Earnings Formula
- Retained Earnings Formula calculates the current period Retained Earning by adding previous period retained earnings to the Net Income (or loss) and then subtracting the dividends paid during the period.
- Whenever the company generates a surplus it will always have the option of whether to pay a dividend to its shareholders or retain with itself.
- Further, if the company is making huge profits then its shareholders would expect regular income in the form of dividends for risking their capital.
- If the company expects more investment Opportunities and will earn more than its cost of capital, then it would intend to retain the funds instead of paying dividends
- And if a company thinks the expected returns from opportunities will yield low returns then it will wish to pay them as a dividend to its shareholders.
- Among a few factors, thoughtful consideration could be given to trends and past performance as to how efficiently retained earnings were utilized by the company while looking for long term value investments or dividend payouts.
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