Retained Earnings

What is the Definition?

Retained earnings are found under the equity section on the balance sheet. As the name indicates, retained earnings are the remained earnings after paying off the dividends to shareholders. Therefore, it increases when profits are made and decreases when dividends are paid or loss of money (decrease in profit).

It is worth noticing that most growth-oriented companies do not pay off dividends to shareholders. In contrast, they prefer to reinvest retained earnings in other uses, such as Research & Development. A typical example of such companies is Tesla. The decision to retain the earnings, pay them to shareholders, or use them in other places, is determined by the company's management team. Therefore, it is an essential ability for investors (us!) to explore the reason behind the numbers. In this case, when we analyze the retained earnings, it is always important for us to understand the decisions behind this metric.

Calculation

Retained Earnings = Beginning Retained Earning + Net Income -Dividends

Why Is It Useful?

As most financial values & ratios do, retained earnings can indicate various aspects of a company. For example, it can imply a company's profitability. In addition, it reveals the management team’s decision on how to allocate the excess profit.