Every business is concerned about the expenses and income situation. In economics, there are several important terms that must be understood for example, like retained earnings or retained incomes. What is retained earning? The definition of retained earnings itself is profit that has been obtained by a company starting from the establishment of the company, minus the cumulative amount of dividends.
In short, retained earnings can be explained in other easy words as a company’s previous earnings or profits that have not been given to the company’s shareholders. The amount of retained earnings is reported as a separate component of shareholder equity.
Later retained earnings can be used to finance business expansion or pay dividends to future stockholders.
Is Retained Earnings a Corporate Capital?
Sometimes company does not give distribute or give earnings to its shareholders so in this way retained earnings would be considered as part of the company’s capital. Retained earnings itself comes from the operational and non-operational activities of a company. Profits from selling company assets can be categorized as retained earnings.
Retained earnings can be used in future
Although the profits obtained by the company are retained, the money can still be used again in the future, both to be distributed to shareholders and to develop the company’s business. Some of the profits must be retained as deposits to finance future activities such as paying off corporate debts, company operations, and business development.
Retained Earnings function
Keeping the retained earnings as company profits is certainly not without reason. Here are the functions or benefits of retained earnings.
Business development through retained earnings
Profits retained by the company and not distributed to shareholders can be used to finance business development. Business development is also of various kinds.
Management is able to build a new factory, buy new operational tools such as machines or computers, add a company’s land bank, invest in the capital market, acquire other companies. All business development activities require large costs and retained earnings can be used as capital.
This is where the major benefits of retained earnings are recognized by the company, where the capital is needed to develop the business. Company does not want to acquire new loans. When it has retained earnings then company get rid of extra burden of interests.
Retained earnings to pay Company Debts
In financing operational activities or developing businesses, it is not uncommon for companies to borrow funds from other parties. Loans or debt that must be paid by the company can be covered with existing retained earnings, especially for long-term debt that will mature in the near future.
Usually long-term debt has a large nominal value, so it becomes the first priority to be paid immediately. Debt that is not paid when due is very risky because the company can be bankrupt by creditors.
The company has several options for paying large amounts of debt, including by issuing new shares. But of course these activities require large capital. By paying debt using retained earnings, the company does not need to spend additional capital.
Retained earnings to Finance Company Operations
Retained earnings or retained incomes can also be used to finance the operations of the company. This is very profitable, especially for companies that are developing and need a lot of money to fund their activities. The more a company develops, the more complex its activities are. Thus requires a greater cost.
If you use retained earnings to finance these operational activities, the company no longer needs to borrow capital from other parties and increase the debt that must be borne. The retained earnings would make sure the success of business operations.
The extra burden of debt or interest will weaken the interests or profits level of shareholders as well.