Income is the total income generated from the sale of goods and services, while retained earnings is the net income amount held by the company. Both income and retained earnings are important in assessing the financial condition of the company, but also to highlight different aspects of the financial picture.
The company is located in the upper part of the income statement and is often referred to as top of the line in the description of the financial results of the company. Since profit is the total income earned by the company is income before operating expenses and overhead are deducted. In some industries, company is called gross revenue, as the total figure to the deduction. However, net sales can be used in place of sale with net sales refers to revenues net of the exchange or return of goods by customers. For example, the sales volume is used in the retail industry.
Retained earnings is the portion of the profits of the company which is held or stored and saved for future use. Retained earnings can be used to Finance expansion or pay dividends to shareholders at a later date. Retained profit refers to net profit, as it is the sum of net income saved the company over time.
Net profit is the profit earned for the period and is calculated by subtracting all costs of doing business. These costs include operating expenses such as rent, utilities and wages, overhead expenses and sales, General and administrative expenses, interest on debt, and depreciation.
Net income is often called the bottom line because it sits at the bottom of the statement of profit and loss. When net income not paid to shareholders or reinvested back into the company, it becomes retained earnings. It is important to note that retained earnings is the accumulated balance, which may be the result of many quarters or years, similar to a Savings account.
The Calculation Of Retained Earnings
Retained earnings listed on the balance sheet section of the company’s equity. However, it can also be designed for beginning retained earnings, adding net income (or loss) for the period, with the subsequent deduction of dividends paid to shareholders.
For example, the company has the following figures for the current period:
- The beginning retained earnings balance of $ 5,000, when the reporting period began,
- Net income of $4,000 for the period
- Dividends paid in the amount of $ 2,000,
Retained earnings at end of period:
Beginning balance retained earnings + Net income (or net loss) – dividends
Retained Earnings = $5,000 + $4,000 – $2,000 = $7,000
The difference between revenues and retained earnings is the profit is the total amount of income from the sale while retained earnings reflects the portion of profits a company keeps for future use.
Income and retained earnings are correlated with each other, since a significant portion of revenue as profit, may ultimately become retained earnings. The amount of profit is held in retained earnings is particularly important for shareholders as it gives an idea about the company’s ability to Finance dividends and share buybacks in the future.
The ratio between income and retained earnings can also illustrate how effectively the company invests in long-term health of the company. For example, the company can use retained earnings to Finance the purchase of fixed assets or property, plant and equipment.
The amount of profit remaining can show how well the company manages their earnings after expenses, how effective is it in its activities, whether holding a large amount of cash, and whether to be too aggressive or too conservative in their investments or expansion capital.
Because retained earnings is the cumulative amount of net income, it can be much more with older companies compared to new companies. One method used to compare the retained earnings of the various companies to divide retained earnings by the total number registered in the company years in operation. The result provides the average retained earnings amount.
For more on this topic, please read, what transactions affect retained earnings?