A company may reinvest earnings instead of paying out dividends.
These earnings do not necessarily sit in a retained earnings account, but are used to improve the business and make it more profitable. This could even include paying off debt.
Retained earnings is found in the Shareholder’s Equity portion of a company’s balance sheet. Despite the fact that earnings have not been dispensed to them in the form of dividends or share buybacks, shareholders will see the value of their stock appreciate when earnings are retained and used to grow the business.
Common uses of retained earnings are to fund a new round of hiring, upgrading equipment, or acquiring a small company. This can also be called “retained surplus,” or even viewed as a “retention ratio.”
The Retention Ratio is the opposite of the Payout Ratio, which is the percentage of net income which is paid out as dividends. The Retention Ratio can also be called the Plowback Ratio, as in the amount of money that is plowed back in to the company to fuel future growth.
Retained earnings is a running total of net income which is directed back into the company, so each year’s retained earnings are added to the total from the years before.
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