Retained profit is the money that your business has acquired after payments and costs are
taken into account. It is an important concept for every business as it can indicate the
financial stability of the business, as well as showing what funds are available to put back into it.
What Exactly Is Retained Profit?
Essentially, retained profit is the money a business makes that doesn’t have to be paid out
into dividends. Does it mean anything for the sole traders and businesses that don’t pay out
dividends? Well – yes, as it can show what profit is available to them to finance the
business.
If you retain profits in the business, you won’t have to rely on other types of funding such as
grants or loans. You could also choose to invest them in other inventories, or use it to
reduce overdraft.
How Do I Work Out My Retained Profits?
To work out retained profit, you just need to use this simple formula:
Retained profit = beginning retained earnings + net income or loss – dividends
The figure is usually calculated at the end of each accounting period.
What Do Retained Profits Look Like On A Balance Sheet?
On the balance sheet, retained profit goes into the equity section. It will appear alongside
other forms of equity, such as owner’s capital, though retained profit is different as it is
considered earned rather than invested.
As the figure doesn’t take into account bank balance or cash flow, it doesn’t necessarily
show the business’ current success. Despite this, it still provides a helpful indication of your
business’ general health.
Perhaps the most important part, is that the retained profit will give you an idea of what
should be invested in the business, and can also attract other investors too.
The Advantages Of Retained Profits
Some of the key advantages of retained profits include –
Increased stock value – keeping what your company earns will increase your balance sheet, leading to stockholder equity and value. On paper, retained profits will make your business look better, as there will be more money in your accounts. If your finances look good on paper, this can lead to further investment.
Flexibility – you will have complete control over reinvestment and what is kept rather than paid out in dividends. Having this control can allow you to drive your business’ growth in the way you have envisioned it.
Financial security – your reserves will come out of your retained earnings and can help pay for balance sheet debts. Retained profits can also cover you for emergencies. Plus, as you are financing your business yourself, you don’t have to borrow money, so you don’t have to go through the tough process of applying for grants or loans.
The Disadvantages Of Retained Profits
External funding may be quicker – receiving money from elsewhere might be more helpful to your business in the early stages, as you don’t have to wait until you’re making a profit. Interest rates of borrowing money could also be more advantageous.
Missing out on external expertise – in some cases, with external funding comes expertise and advice. An example of this is an angel investor, which is somebody who invests money into a business, but also supports the business when the majority of investors aren’t ready to back them.
Unsatisfied shareholders – while some shareholders will back the business’ choice to reinvest the money, others may be disgruntled as they might want to receive higher pay-outs. This could also affect the opinion of potential investors.
To Conclude
Thank you for reading our article about retained profits and we hope it has been
informative. Please consider having a look at our other articles.
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