Retained earnings is a subaccount of the owner’s equity, or shareholder’s equity, section found on the balance sheet. As the name states, retained earnings are those that the business retains. They are also known as profits. You can calculate retained earnings by using the following formula: Beginning retained earnings plus net income minus dividends equals retained earnings.
Retaining earnings are equivalent to the initial retained earning level combined with your net income, minus any dividends.
Defining Retained Earnings
First, it's important to understand that retained earnings is the amount of net income the company carries over from year to year. For example, at the end of the first year of operation, a company has $10,000 of net income it decides to keep. This becomes the company’s retained earnings. At the end of the second year, the company has $20,000 in retained earnings.
The total retained earnings at the beginning of the third year is $30,000 ($10,000 plus $20,000). When net income increases, the retained earnings amount increases. When net income decreases, the retained earnings amount decreases.
Exploring the Role of Capital Stock
Realize the role capital stock plays in retained earnings. Capital stock includes preferred and common stock shares. Calculate the common stock dividend by multiplying the number of common stock shares by the declared dividend amount. For example, if a company declares a 5-cent dividend on 100,000 common stock shares, multiply 100,000 shares by 0.05 to get the dividend amount of $5,000. Preferred stock is paid a dividend based on a percentage stipulated upon issuance of the shares. For example, if a company declares a dividend on 50,000 shares of preferred stock paying an 8 percent dividend, multiply the 50,000 shares by 0.08 to get the dividend amount of $4,000.
Assessing Financial Statements
Write down the formula, "Beginning retained earnings plus net income minus dividends equals retained earnings." Go to the company website and find the financial statements. Find the income statement and scroll down to the amount listed on the net income line. Write that amount under the net income part of your formula. Find the balance sheet and scroll down to the owner’s equity/stockholder’s equity section. Locate the beginning retained earnings amount. Write that amount under the beginning retained earnings part of your formula.
Defining Preferred Stock
Find the preferred stock line in the owner’s equity/stockholder’s equity section. Preferred stock dividend information will be disclosed on that line. If a dividend was paid, enter the amount under the dividends part of your formula. Find the common stock line. If a common stock dividend was paid, the information will be disclosed there. Write that amount under the dividends part of your formula. Now add the beginning retained earnings amount to the net income.
Final Retained Earnings Amount
Subtract the preferred and common stock dividends from that amount. The amount calculated is your retained earnings. For example, add the beginning retained earnings amount of $100,000 to net income of $50,000 to get $150,000. Subtract preferred stock dividends of $4,000 and common stock dividends of $5,000 from the $150,000. The retained earnings amount is $141,000.
Items you will need
- Corporate financial statements