A statement of retained earnings is a financial report that shows the net income and profit of the business after dividends have been paid to shareholders. These earnings can be kept and reinvested in the business. This statement is intended for outside parties, such as creditors or investors.
The statement of retained earnings is one sub-section of the larger statement of stockholder equity. This shows all equity accounts’ changes over time.
A Statement of Retained Earnings is a must
For internal decision-making as well as the dissemination of information to interested parties, businesses must prepare a statement on retained earnings.
Internal Decision Making
For business owners, a statement of retained earnings is required to keep track of their accumulated retained income or the percentage of net income that has been allocated to retained earnings since its inception.
Management is also aided by the statement of retained earnings. It allows firms to calculate their retention ratio. The retention ratio measures the percentage of net income retained. If 60% of net income goes to dividends, then 40% of net income will be retained. The dividend payout ratio is the opposite of the retention ratio.
For Creditors
You may have debt lenders or institutions that have loaned money to you if you’ve used debt financing. Statements of retained earnings show creditors that your firm is financially stable enough to be able to pay off your debts.
For Investors
Investors who see money being funneled back into the company for growth are more likely to be satisfied with its health. Stock prices may rise if a company expects growth. Investors look for a company’s stock price increase to indicate that its management is focused on maximizing shareholder wealth.
Prepare a Statement of Retained Earnings
The components of a statement of retained earnings are not complicated and require a series of steps. Below is an outline.
The heading
To identify a statement of retained earnings, it should include a header with three lines. The company name should be on the first line. The second line simply states, “Statement on Retained Earnings.”
Describe the Retained Earnings Balance from the Previous Year
The balance of retained earnings that you have from previous years should be the first item on your statement of retained earnings. This figure is derived from the balance sheet for the previous year.
This is how the first line of the statement of retained earnings would look if the retained earnings balance for a hypothetical company was $20,000.
Add net income to the income statement
The net income or loss is the second item. The retained earnings statement will look something like this if the company has a net income of $10,000 in the current year.
- Retained Earnings December 31, 2019, $20,000
- Plus: Net Income 2020 +10,000
- Total: $30,000
Subtract Dividends Your Company Pays to Investors
Subtract the dividends paid by the hypothetical company from the net income. Subtract $0. if it doesn’t pay dividends. If the company has a dividend policy that pays 50% of its net income to investors, then subtract $0.
Below is the layout:
- Retained Earnings, December 31, 2019, $20,000
- Plus: Net Income 2020 +10,000
- Total: $30,000
- Minus: Dividends (5,000)
Dividends, regardless of whether or not they have been paid, are considered a debit or reduction in the retained earnings account. For example, a Widget Corporation board declares a $5.00/share dividend on 10,000 shares of stock. $50,000 is deducted from the company’s retained earnings, even though the dividend has not been paid.
Calculate the final total for retained earnings
Add the dividends if any, to calculate the total for the statement with retained earnings. This is the amount that has been posted to the retained earnings account in the 2020 balance sheet.
- Retained Earnings, December 31, 2019, $20,000
- Plus: Net income 2020 10,000
- Total: $30,000
- Minus: Dividends Paid ($5,000)
- Retained Earnings December 31, 2020 $25,000
Additional Information
While preparing a statement of retained earnings is easy, there are more details than the example. Sometimes, the par value of the stock (its declared price at issue) is indicated with a higher level of detail.
Always consult your accountant before filling out any financial statements. This will ensure that you comply with all accepted accounting principles and the most current formats.
Most Frequently Asked Questions
What items are not included on a statement regarding retained earnings?
Statements of retained earnings do not include cash flow.
What financial statement is used instead of a retained earnings statement by corporations?
Instead, corporations can use the Statement of Stockholder’s Equity.
What items are on a statement of retained earnings as well as a balance sheet?
Both the balance sheet as well as the statement of retained earnings contain the accumulated retained earnings balance from the previous year. This is the first line item of the statement of retained income.
