Retained earnings are part of the company's net income that is retained by the company and is not paid out as dividends to shareholders. This money is usually reinvested into the company, to become the main fuel for the company's continued growth, or used to pay off the company's debts. Calculating retained earnings and preparing a statement of retained earnings is an important part of an accountant's job. Usually retained earnings for a certain reporting period are calculated by: reduce net income by dividends to be paid by the company to shareholders.
Step
Method 1 of 2: Knowing the Meaning of Retained Earnings
Step 1. Know how to record the retained earnings of a business
Retained earnings is a fixed account in the balance sheet of a company under the title Shareholder's Capital. The balance of this account reflects the cumulative profit that has not been distributed to shareholders in the form of dividends since the company was founded. If the retained earnings account has a negative balance, this is referred to as "accumulated losses."
By knowing the cumulative retained earnings balance since the company was founded, you will be able to calculate the company's retained earnings balance for the next reporting period. For example, if your company has cumulative retained earnings of $300,000 and you generate retained earnings of $160,000 during the current reporting period, you will find that the cumulative value for retained earnings is $460,000. Over the next period, if you generate another $450,000 in retained earnings, you will have a total retained earnings of $910,000. In other words, since your company was founded, you already have $910,000 to "keep" the company after payment of wages, operating expenses, dividend distribution to shareholders, etc
Step 2. Know what the relationship between corporate investors and retained earnings is
Investors in a profitable company will expect the return on their investment in the form of dividends. After all, investors always want their company to grow and earn bigger profits so that its share price goes up, and gives investors more money in the long run. For a company to grow effectively, retained earnings must be reinvested into the company. Usually this is done by using retained earnings to increase efficiency and/or expand the business. If successful, this reinvestment causes the company to grow, increases the company's profitability, share price, and allows investors to earn more money than if they had asked for a larger dividend in the first place.
- If a company succeeds in making a profit and retains a large amount of profit but the company still cannot grow, investors will usually ask for larger dividends because the money they have allowed to be "kept" by the company is not being used effectively to provide the money they need. more to them.
- Companies that do not hold profits or pay dividends will not attract investors.
Step 3. Know what are the factors that affect the amount of retained earnings
Retained earnings of a company can fluctuate from one reporting period to the next. However, this is not only due to changes in the company's revenue stream. Other factors that can affect the company's retained earnings are as follows:
- Change from net receipt
- Changes in the amount of money paid out as dividends to investors
- Changes in cost of goods sold
- Changes in administrative costs
- Changes in taxes
- Changes in the business strategy of the company
Method 2 of 2: Calculating the Company's Retained Earnings
Step 1. If you can, collect the necessary data from the company's financial statements
Every company is required to officially document their financial history. If you can do this, it's usually easier to calculate retained earnings for the current period using the figures from this white paper to find out the amount of retained earnings at a given date, net income, and dividends paid, than if you had to calculate them manually.. The company's retained earnings up to the last recording period and shareholders' equity will be shown in the balance sheet, while the company's net income will be shown in the income statement for the current period.
-
If you can get all this information, you can calculate retained earnings with the following formula: Net profit – dividends paid = retained earnings.
Next, to calculate cumulative net income, add the retained earnings figure you just calculated to the current retained earnings balance
-
For example, suppose at the end of 2011 your business had a cumulative retained earnings balance of $512 million. During 2012, your business generated a net profit of $21.5 million and paid dividends of $5.5 million. The ending balance of retained earnings from your business is:
- 21, 5 – 5, 5 = 16
- 512 + 16 = 528. Your business already has $528 million in retained earnings.
Step 2. If you don't have information about net income, start by calculating gross profit
If you can't access the exact net profit value, you can calculate the net profit of a business by calculating it manually through a slightly longer process. Start by calculating the company's gross profit. Gross profit is a number that is generated from the income statement in stages and is calculated by subtracting the money from the sales proceeds from the cost of goods sold.
-
For example, suppose a company achieves sales of $150,000 in one quarter, but has to pay $90,000 for the goods needed to generate sales of $150,000. Gross profit for the quarter was $150,000 - $90,000 = $60.000.
Step 3. Calculate operating profit
Operating profit reflects the company's profit after paying sales and operating expenses, such as wages already paid. To calculate this operating profit, subtract gross profit by the company's operating costs (excluding cost of goods sold).
-
For example, in the same quarter that our business made a gross profit of $60,000, there were payments of $15,000 in administrative costs and wages. Thus the operating profit of the company will be $60,000 - $15,000 = $45.000.
Step 4. Calculate net income before taxes
To calculate net income before taxes, subtract the company's operating profit by interest, depreciation, and amortization. Depreciation and amortization – ie the depreciation of the value of an asset (tangible and intangible) over its economic life – is recorded as an expense in the income statement. If a company purchases equipment for $10,000 with an economic life of 10 years, it will incur a depreciation expense of $1,000 annually, assuming the value depreciates evenly.
Suppose our company pays interest expense of $1,200 and depreciation expense of $4,000. The net profit before tax of our company will be $45,000 - $1,200 - $4,000 = $39.800.
Step 5. Calculate net income after tax
The last cost we have to take into account is taxes. To calculate net income after taxes, first multiply the company's tax rate by net income before taxes. Next, to calculate net income after taxes, subtract this multiplied number from the net profit before taxes.
- In the example we discussed, we assumed that the tax rate was 34%. The tax fee we have to pay is 34%(0, 34) x $39,800 = $13,532.
- Next, we subtract this number from the total net income before taxes as follows: $39,800 - $13,532 = $26,268.
Step 6. Finally, subtract the amount of dividends that have been paid
After we calculate the company's net profit after deducting all the costs that are our obligations, we have a number that we can use to calculate the amount of retained earnings during the current accounting period. To calculate it, subtract the net profit after tax by the dividends already paid.
In the example we discussed, we assumed that we paid investors $10,000 in dividends for the quarter. Retained earnings for the current period will be $26,268 - $10,000 or $16.268.
Step 7. Compute the ending balance of the retained earnings account
Don't forget that retained earnings is a cumulative account that shows the net change in retained earnings since the company's establishment to date. To find out the amount of retained earnings as a whole, add the retained earnings of the current period to the ending balance of retained earnings at the end of the previous accounting period.
