Retained earnings represent the amount a company has left after it has paid all its expenses, taxes, and dividends. A company can return all the cash it has left after it has taken care of its obligations, but that would handicap its efforts to expand operations, make acquisitions, and replace equipment. Some investors like when this figure is returned to them in the form of dividends, but most do understand that something must be reinvested for the long term.

How to Calculate Retained Earnings

The formula to calculate retained earnings is quite simple. The figure is calculated by adding the net profits (less dividends paid) to the beginning retained earning balance from a previous period:

Retained Earnings (RE) = Beginning RE + Net Income – Dividends

If there is a net loss and it is larger than the beginning retained earnings, there will be what is called negative retained earnings.

Why Retain Earnings?

Companies may retain earnings as a strategic move; they may later spend the reserves on research and development or company acquisitions, to name a few. An example of a company that has a huge hoard of cash is Apple Inc. The company’s cash reserve of more than $40 billion is larger than the entire market capitalization of many Fortune 500 companies.

Why does Apple Inc need so much cash? In the words of Steve Jobs, the company’s CEO, "Our judgment and our instincts tell us to just leave that powder dry right where it is right now and it's going to come in awfully handy one of these days."

Of course, some investors would like to see the company return some of the money to investors, whether by share buyback, which increases the value of outstanding shares, or in dividends that give investors cash. However, if the company continues to be properly managed, the strategy should bring greater shareholder value in the long term.


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