Understand the Function, Formula and Examples of Retained Earnings for Your Business

When building a business, there is one thing that is often overlooked, namely how to manage profits intelligently.

Many businesses directly distribute net profits to shareholders in the form of dividends. 

In fact, there is another strategy that can help a business develop further, namely retained earnings.

Well, retained earnings are profits retained by the company for various strategic purposes. 

Starting from expansion, debt payments, to product innovation.

By understanding this concept, your business can progress further and be ready to face future challenges. Now, let's discuss them one by one in this article, take a look!

What is Retained Earnings?

So, what is retained earnings? Simply put, retained earnings are net profits that are not distributed as dividends, but are retained for business purposes. 

So, does the company's financial report also record retained earnings?

In financial reports, retained earnings are usually recorded in the statement of retained earnings. 

So, if you see a retained earnings balance in the company's financial statements, that means there are funds that have not been distributed to shareholders. 

In essence, the statement of retained earnings is a report that shows changes in the balance of retained earnings in a period. 

This report is important, because it helps business owners understand how the profits generated are used or reallocated. 

Therefore, you must understand why retained earnings are important? Come on, let's discuss it again below!

Read Also: Don't Take Notes Wrong! This is an example of a correct sales journal for your business

Why are Retained Earnings Important?

The main reason many businesses choose to retain profits is because it can be used as a special strategy. In short, retained earnings is a strategy that can strengthen a company's financial position. Well, here's another reason why retained earnings are important:

1. Funds for Expansion

Source: Freepik

If you want to develop your business, retained earnings can be capital to open new branches or add product lines.

2. Debt Payment

Source: Freepik

Apart from expansion, with retaining some profits, companies can reduce their debt burden without having to seek external funding.

3. Future Fund Reserves

Source: Freepik

Lastly, definitely business goes through ups and downs, right? Therefore, with retained earnings, the company has reserve funds when market conditions are uncertain.

These are some of the main reasons why many businesses choose to use a retained earnings strategy. The question is, what is the retained earnings formula? Check it out below, OK!

The Retained Earnings Formula that You Must Understand

Well, to make it easier to understand how to calculate retained earnings, here is the formula you need to understand:

From this formula, we can see that retained earnings are the result of net profit after deducting dividends distributed. 

If the company does not distribute dividends, then all net profits will go to retained earnings. You understand, right? To make it easier, we will use this example of calculating retained earnings.

Example of Retained Earnings Calculation

For example, a company has an initial retained earnings balance of IDR 100 million. In one year, the company generated a net profit of IDR 50 million. 

However, the company distributed cash dividends of IDR 10 million and stock dividends of IDR 5 million. 

So, retained earnings are calculated as follows: 

So, the company's retained earnings balance after one year is IDR 135 million. So, these funds can be used for business expansion or other investments.

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How Can Retained Earnings Be Used?

After understanding how to calculate it, now we discuss the use of retained earnings. Here are some ways companies use retained earnings, you should know!

1. Investment in New Assets

The first, a company can use retained earnings to purchase new machinery, property, or technology.

2. Increase Working Capital

Apart from investment, through strategy retained earnings, the company can strengthen operations without having to seek additional loans.

3. Future Dividend Payments

If financial conditions permit, the company can distribute larger dividends in the future period.

4. Merger or Acquisition

Lastly, businesses that want to grow more quickly can use retained earnings to acquire other companies.

Appropriated Retained Earnings vs Unappropriated Retained Earnings

Oh yes, you should also know that there are 2 types of retained earnings that you must understand! This is important, so that you can choose and apply retained earnings that suit your business! In In the business world, retained earnings can be divided into two types, namely:

• Appropriated Retained Earnings are retained earnings that have been allocated for certain purposes, for example for investment or debt repayment.
• Unappropriated Retained Earnings are retained earnings that do not have a specific allocation and can still be used for various purposes.

Conclusion

From the discussion above, it can be concluded that retained earnings is an important element in a business's financial strategy. So, by understanding the concept and how to calculate it, you can manage profits smarter while ensuring your business continues to grow. 

Managing business finances, including retained earnings, is not an easy thing. However, you can more easily track and analyze business finances with ESB Core!

Through the Business Intelligence feature, ESB Core helps you understand the financial condition of the business in detail. In addition, an integrated stock management and financial analysis system makes business management more efficient. Use ESB Core now and improve the performance of your restaurant business!