People do business to earn income. Facing daily winnings and losses is tough, but business people stick with it and strive until goals are achieved. To finish what they started? No. They remained to watch what they had now grown to become. Business growth is always the objective of every business plan.
Constant change and daily challenges are what entrepreneurs tackle to bring more growth and benefits to the business and all involved with all business activities. That’s why those in business always look for innovation and strategies to help improve business performance. Among these strategies is the use of the retained earnings account to boost the financial status of your business.
What Are Retained Earnings?
In business, retained earnings refers to income or earnings left or computed to remain in the company’s coffers. It’s usually ‘reserved’ every income period after the business has paid off all its taxes, direct and indirect costs, and dividends to all its shareholders or partners. Company stakeholders consider this reserved income as funds for future spending that will benefit the business. Some usually earmark this for future expansion, like a new building, new investment, machinery, marketing, and research and development expenses.
Retained earnings are essential factors when determining a company’s overall financial health. Significantly, it indicates the amount of net income a company has saved after years of operation. As a result, the firm has backup funds to reinforce its ability to reinvest, upgrade business activities or distribute to shareholders.
Uses of Retained Earnings For Your Business Growth
To gain more investments or assets in promoting business growth, retained earnings can be used in various ways:
- Fund For Expansion
Retaining your company’s profits leads to growth in your balance sheet. It’ll, in turn, have a domino effect on stockholders’ equity, including the stock value directly proportional to that. Your company will have a better appearance on paper and more money in its accounts if you keep a portion of its profits.
Steady profit savings will be an effective presentation to draw in more investors. The more investors you have, the more opportunities you and your business can engage in, including business expansion.
Starting a business is never enough. Thus, making good and expanding growth is always an entrepreneur’s goal. And building funds for future expansion is not an easy feat. You need to save, accumulate, and reserve so much profit to finance the projected expansions.
If project expansion has been your objective ever since, save up and build up your retained surplus. It’s always better for you to fund business expansion on your own and save up on interest and other charges.
- Finance Brand Launching
Marketing and networking are today’s channels where business products and services can successfully reach their target market. Your business product needs a considerable chunk of funds to finance its networking, advertising, and marketing strategies to launch to its consumers effectively. Constant product change and innovation to serve its market is the cause and reason for staying in business. That’s why for some companies, it drains their money box.
There are many ways to finance the cost of bringing your brand upgrades or new products to its target end users. You can take out fresh funds as additional capital, invite an angel investor or private investor who can support your marketing endeavors, or use your accumulated retained earnings. Whichever step, you need to show a few years’ comparative positive income surpluses.
You can easily fund product launches if your business has saved enough income to finance such endeavors. Sometimes, it’s just a matter of business projections, plans, and programs, though there are always instances where you need outside financial reinforcements.
It’s why a portion of the annual declared income must be saved for a rainy day to beautify your financial portfolio and increase your firm’s capacity to sustain itself. It’s also a sign of sound financial management to do so.
- Increase Stakeholder’s Income Share
Your company will receive both operational and financial support from its stakeholders. Examples of stakeholders are devoted consumers, investors, and employees. They’re the people that have an interest in your business and are concerned about the success of your business. They help you feel less isolated in the work and activities you do as an entrepreneur.
Your firm’s yearly surplus or retained income is your tool to motivate your employees, increase shareholders’ dividends, and extend freebies to customers and marketers. Your company’s net surplus at the end of the year may improve your workers’ pay to encourage better work performance.
It’ll also make your stockholders happy. Most of the time, an increase in the dividend payout encourages loyalty and increased investment from your shareholders. Stockholders will always consider your business a priority in their investments if they always get a good return for their money.
- Foundation For Merger or Acquisition
Transactions involving mergers and acquisitions don’t necessarily include the exchange of money every time. In certain circumstances, it’s possible to consummate a merger by treating your equity as a form of cash and then negotiating a proportionate share in the firm you merge with. It’s also true when using your saved-up equity to acquire another company.
Merging with another firm and business acquisitions are strategies to expand your brand or business. These steps may challenge you financially. But suppose you’ve saved enough income through years of good business practices. In that case, you can expand the way you do business through mergers and acquisitions without additional capital or investors.
A hefty sum in your retained earnings account is a good foundation for entering into mergers and acquisitions to increase the scope of your brand or products. So, if you have been working on building up your treasury for some time, go for it. The excess income you have kept can effectively vouch for any expansion you may see necessary in the future.
What Are Its Implications?
A high retained earnings level may be indicative of a healthy financial position. It reflects a history of productivity and prosperity from earlier years of conducting business. On the other hand, it may indicate that the corporation or the company has to reconsider the amount of the dividends it pays out to its shareholders. Of course, this depends on whether or not the organization has been actively exploring prospects for profitable expansion.
The ratio of retained earnings to total assets should ideally be 1:1 or equal to total assets in value. On the other hand, the vast majority of companies will never achieve such a ratio. Their most achievable goal would be to have a ratio that’s above the industry average. They strive to increase and bring near to one hundred percent as possible.
Are There Businesses With No Retained Earnings?
Some businesses don’t have retained earnings in their books. Startup firms that have not yet earned income will have zero retained earnings. There’s a Retained Earnings Account, but it has zero in its records. Understandably, these companies are still sustaining their activities through debts and capital contributions from their stockholders. And at this point, these companies haven’t yet reached the status where they can generate, recycle, and reserve profits.
Technically, there are also no retained earnings in the books of accounts in partnerships, sole proprietorships, and some limited liability companies. They have excess income, but it’s labeled differently on their balance sheets. Some firm owners label their retained income as surplus or under the owner’s equity account in their balance sheets.
With sole proprietorship companies, there’ll be no need for a retained earnings account because all their profits are added directly to the owner’s equity. Partnership businesses book the same under their partnership’s equity account.
What’s A Negative Retained Earnings
Even if a corporation suffers a loss, it can still be factored into the retained earnings calculation. A profitable firm may find itself having retained earnings if it has paid out dividends and other expenses. That, taken together, amounts to a more significant sum than the total of the company’s profits ever since it was established.
Because they imply that there has been a consistent stream of losses over time, negative retained earnings can be an early warning sign of impending insolvency. Negative retained profits may indicate that a company was allowed to borrow funds and transfer these monies to stockholders as dividends. However, this move is typically forbidden by the loan covenants imposed by a lender.
In A Nutshell
There’s a plethora of methods in which you can use your retained money to expand your company. You might only notice a handful of them in this listing. Still, there are links where you can explore different ways to make productive use of your resources.
Whatever strategies you come up with, you’re the boss. But it still pays to have accumulated retained earnings to fund many business pursuits and expand your business. At the same time, increase your surplus. Saving is a good business practice. So, save up, grow your business, and earn more.