Definition of Retained Earnings
Retained earnings is one part of a corporation’s stockholders’ equity. The amount reported in retained earnings is primarily 1) the cumulative amount of the corporation’s earnings and losses from the day the corporation began, minus 2) the cumulative amount of dividends distributed to the stockholders from the day the corporation was formed.
Large, profitable corporations may have retained earnings in excess of $1 billion. Newly formed corporations may have negative retained earnings, which are reported as a deficit. State laws require corporations to have a positive amount of retained earnings in order to pay cash dividends.
It is important to note that retained earnings does not mean that the corporation has the amount in the form of cash. To determine the corporation’s cash balance, you must look at the asset section of the corporation’s balance sheet.
Examples of a Corporation’s Retained Earnings in Relation to Its Dividends
When a corporation’s board of directors must decide on the amount of dividends to declare and distribute to its stockholders, the following corporation information should be considered:
- Present cash balance
- Cash needed to finance the business operations (growth, inflation, etc.)
- Cash needed to finance future capital expenditures
- Ratio of debt to stockholders’ equity
- Ability to maintain or increase the present cash dividend
The above considerations could mean that dividends will not be increased even though the corporation has a huge amount of retained earnings.
