Retained Earnings are a financial metric that offers a valuable insight into a company’s financial health, extended stability and potential for future growth. They represent the profit a company has retained overtime after accounting for all liabilities including the payment (if any) of dividends.
The Cambridge Dictionary defines Retained Earnings as:
“The part of a company’s profit in a particular period (Financial Year) that it decides to keep, rather than paying it to shareholders as a dividend.”
Why are Retained Earnings important?
Growth
Retained Earnings are habitually used to fund expansion. This includes purchasing more stock, producing new products, and entering new markets without the need to finance externally.
Financial stability
Retained Earnings act as a financial safety net allowing companies to traverse poor economic times while still having the capital to seize arising opportunities.
Credibility
Retained Earnings signal strong financial stability, consequentially, increasing a company’s ability to attract and retain lenders.
Impact of Retained Earnings on Shareholders
Stock price growth
As a company reinvests and grows often so does its stock price, leading to the potential growth in stock value for investors.
Dividend Income
Retained Earnings can be used to maintain or increase dividend repayments, providing income stability or growth to investors.
Calculating Retained Earnings
To calculate Retained Earnings (RE), subtract or add the net income/loss (NI) to the Retained Earnings from the previous fiscal year (RE0) and then subtract any dividends paid (D).
Tax implications of Retained Earnings
Retained Earnings are derived from the net income (Bottom Line) of the previous fiscal year, representing the profit left after subtracting all liabilities including any company tax obligations, from the gross revenue. As a result, Retained Earnings are not subject to additional tax implications beyond what has already been deducted from the gross revenue.
It’s important to mention that dividends paid from the Bottom Line instead of being retained can be franked appropriately to prevent double taxation. (click here to learn about franked dividends)
Key takeaways about retained earnings
- Retained Earnings are the cornerstone of a company’s financial stability and growth.
- Retained Earnings are likely to be looked on favourably by lenders.
- Retained Earnings are the ‘Bottom Line’ and therefore have no further tax implications.
Links and further references
Related information on retained earnings
ATO – Retained earnings and distributable surplus.
Further information or advice on tax law
If you need advice on tax law for your business, contact us for a confidential and obligation-free discussion:
Malcolm Burrows B.Bus.,MBA.,LL.B.,LL.M.,MQLS.
Legal Practice Director
T: +61 7 3221 0013 (preferred)
M: +61 419 726 535
E: mburrows@dundaslawyers.com.au
Disclaimer
This article contains general commentary only. You should not rely on the commentary as legal advice. Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.
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