Retained earnings are the profits generated to date less any dividends or distributions paid. Retained earnings are reported in the balance sheet and the owner’s equity statement and are classified as an asset as it has a positive value. Retained earnings are not paid out as distributions or dividends but are retained by the business entity to be reinvested in core business activities or to pay down debt.
From an accounting perspective the retained earnings at the end of an accounting period become the opening retained earnings for the next reporting period which is either increased if there is a net profit or decreased if there is a net loss.
Retained earnings are a reflection as to how a business has managed its profits and does not represent surplus cash available to the business. Retained earnings are important as it demonstrates what a business has done with profits.
While a profitable business will expect a return by way of distributions or dividends there is also an expectation that a business will grow thus becoming more profitable. This means that a business will use retained earnings to grow.
Retained earnings can fluctuate from one reporting period to another and while the general consensus is that revenue is the key driver, the other factors that have an affect are increases of decreases in items such as the cost of goods sold, administration costs, taxes, distributions or dividends.