Retained Earnings Normal Balance
The most important thing for any business is to make as much profit as possible. This is why business owners know what the retained earnings and retained earnings normal balance are, how to calculate them, and what it all means. Retained earnings are part and parcel of running a business. Retained earnings represent money that can be distributed to owners and investors or spent on furthering the business.
Every business owner should understand what retained earnings normal balance covers and how these earnings are recorded, even though it’s likely going to be the accountant that handles the bulk of the work.
What is Retained Earnings Normal Balance?
The question of “what is retained earnings normal balance?” isn’t difficult to answer. This refers to a credit in the retained earnings account. The credit shows that businesses have generated profits. However, the actual figure in the retained earnings journal entry might be relatively little, no matter the financial health of the company. Any dividends you owe are paid from this particular account, meaning that the credit balance left over isn’t necessarily an indication of business success.
If you have a negative normal balance of retained earnings, then it means that the business is operating at a loss. Negative debit retained earnings are more common for the first year or two of a business, as you spend your time attracting customers and developing products to sustain more profitability.
What are Retained Earnings?
The word “retained” is defined as “to keep” and the word “earnings” means income. Therefore, retained earnings mean how much income a company has left after paying dividends; money that can be reinvested in the business or used to pay off debt obligations owed to others. These retained earnings are an excellent source of internal revenue for business financing as you have total control of the money.
Retained earnings come under the stockholder’s equity when listed on a balance sheet. The money is a financial activity and has earned the capital portion of a stockholder’s equity. Retained income is one of several things that connects an income statement and balance sheet. The total retained earnings amount is connected to the overall net income, including things such as investing, liabilities, and paid dividends.
Net Income vs. Retained Earnings
Net income is covered on the balance sheet. This figure refers to the profits an enterprise has left over after paying all necessary fees, taxes, deductions, or other obligations. Companies can use net income to boost overall working capital for an enterprise, creating funds and cash reserves for further investment, and investing money back into production to increase production. How much net income a business has is down to the amount of generated gross profit and the fiscal burden of expenditures, including taxes, dividends, and other such costs. The more a company makes and the less they have to pay, the more net income they have to play with.
These retained earnings may be used to invest in new or existing fixed assets, or they can be stored as a cash balance for later use or can be circulated across the securities market to generate more net income. The money can also be used to purchase and absorb other companies, provide customers and clients with loans, or repay current company loans. Retained earnings can also be used to boost liquid assets for an organization.
The difference between net income vs. retained earnings is that retained earnings are only one portion of the total net income/profit. It refers to the money that wasn’t used by an organization during a reporting year. Retained earnings are an indication of the financial health of a company. There are several benefits to retained earnings, such as the flexibility and fact that business owners are in control. There are also a few drawbacks, such as the risk of profit hoarding and the fact retained earnings can be a negative balance.
Retained Earnings on Balance Sheet
The balance sheet is an integral part of financial reporting for an organization. This balance sheet is among the five key statements used in annual accounting reporting. The balance sheet outlines all of the assets, equity, and liability of an organization. At the heart of it, the balance sheet is a document that shows the financial condition of a company over time.
The balance sheet is divided into assets and liabilities. The assets section highlights all the property belonging to an organization along with the debts of its counterparties, including fixed and intangible assets, cash, receivables, and inventories. The liabilities section covers the sources of the assets, such as equity, external liabilities, and borrowed funds.
The normal balance of retained earnings is considered a liability as the figure shows the direct debit an organization owes to founders. In an ideal situation, the amount is divided among shareholders and any leftover money is spent on developing the business enterprise. The company can’t distribute or dispose of retained earnings, at least not until the organization owners make the appropriate decision to do so.
The account comes under Stockholder’s Equity on the balance sheet. Stockholder’s equity represents a combination of every asset owned by a company. The figure represents the total authorized, additional, and reserve capital, along with the debit retained earnings.
The retained earnings journal entry typically increases over time as net income left over after paying debts and dividends is added to the entry. However, this doesn’t happen all the time and there I no guarantee that retained income will continually increase. Please note that net losses are also noted in the liabilities section of a balance sheet. When talking about net losses, we’re referring to the negative value.
How to Calculate?
If the retained earnings normal balance is spent wisely, then it benefits the shareholders as much as the company. This is because the company – and the stock thereof – are worth more through wise investment. If that retained income is disproportionately big, however, especially if the money is held in cash, then shareholders can demand greater dividends and feel they are being short-changed.
The formula to calculate retained earnings is simple enough;
Current retained earnings normal balance + Profit/Loss – Dividends = Current Retained Earnings
Most accounting software programs are capable of running the calculation when creating a statement of retained earnings, balance sheet, or another financial statement where the number is recorded.
If you are calculating the number by hand, you’ll have to calculate the following three variables first so you can put them into the equation;
- Beginning/Current Retained Earnings
This figure is the retained earnings normal balance you had when you last calculated it. For example, if you create new balance sheets every month, the current earnings would be how much you had leftover at the end of the previous month.
- Net Profit/Net Loss
You should be able to find this figure on the income statement of the accounting period in question. If you generate monthly income statements, then look at the net loss or net profit from your previous statement.
Dividends are distributed to shareholders at set times. Shareholders all get cash dividends if you issue cash dividends, for example. The more shares the shareholder owns, the greater their portion of the dividends.