Retained earnings are the total profits a business has earned over its life and chosen to keep rather than distribute to its owners. Also called accumulated profit, they form part of equity on the balance sheet and grow each year by the net profit not paid out as dividends.
What it means
Each period, net profit flows into retained earnings and dividends flow out of them. A profit increases the balance; a loss or a distribution reduces it. The movement is set out in the statement of changes in equity, which reconciles the opening retained earnings to the closing figure.
Where it fits in
Payroll affects retained earnings only through its effect on profit. Because all staff costs are deducted before net profit is struck, the profit that ultimately lands in retained earnings is already net of the wage bill. Retained earnings are the link between a period's trading and the equity an owner holds.
Key rules
- Cumulative profit kept in the business, part of equity.
- Increased by net profit, reduced by losses and dividends.
- Movement is shown in the statement of changes in equity.
- Already net of all payroll cost, via net profit.
