Retained earnings may be familiar to those who invest in companies as shareholders, and they are certainly familiar territory for any company that has shareholders. In this definition, the word earnings does not mean employee earnings but it is used to discuss company profits. These might normally be paid out as dividends to investors but it is not unusual for the company to keep some profits held back or to retain them.
There are several reasons why companies keep back these payouts. Theoretically, companies mostly use retained earnings to reinvest in the business. This reinvestment holds with it the promise that companies will grow and make yet more money in the future. Some of this will be disbursed as dividends and some of it will still be retained for greater investment. A healthy company is typically one that is growing, that is increasing its yearly earnings and not falling behind, or simply trying to keep up with expenses. In this ideal scenario, the company keeps back money as a means of making the itself more profitable and successful, and it might spend some of the retained earnings in things like acquisition, research, new facilities, or marketing.
In some examples of retained earnings, companies are trying to keep their heads above water. They have to reinvest in equipment that breaks to keep earning a steady amount, or they continue to be in debt and have to reinvest money retained into repayment of debts. In these cases, company action is important but it doesn’t say much about the company’s ability to grow in the future. When companies continually retain earnings just to maintain the same status or to keep from losing more money, they may not be the soundest investments. Those skilled in advising investors often suggest looking for those companies that use retained earnings wisely and well for growth.
Retained earnings are also defined in a simple formula. This is the total of all retained earnings at present added to the net income made by the company. Total amount of dividends paid is subtracted from this account to get year-end or quarter end retained earning statements. The amount of money that is actually available after it has been retained isn’t always the same as the total earnings stated. Typically the money has been invested, so it is not necessarily available to the company or to shareholders. Rather, many see any total figures here as money that has been invested to grow the company.