If you are looking for business growth, then it is necessary to understand financial health. It is directly linked to the evaluation of the company’s stock value. There are many factors like costs, revenues, retained earnings, net income, and expenses that you need to analyze. In this article, we will particularly discuss retained earnings vs net income, the core difference between these two, and how they are essential for business. If you are a business owner, then you might benefit from reviewing these two key points.
Understanding Retained Earnings vs. Net Income
Retained earnings are also referred to as accumulated profits. It is a key factor that helps businesses to find a happy medium between reinvesting in their enterprise and providing dividends to shareholders. Thus, after paying out dividends, a corporation keeps the remaining earnings and might choose to reinvest them in expanding the company. Some companies also utilize retained earnings to pay off debts.
Understanding RE is helpful when researching potential investment candidates since it reveals whether a business is profitable or not. In case the business has negative earnings, it will be considered debt.
If we talk about retained earnings vs. net income, NI is one of the crucial numbers investors consider while analyzing firms. It is due to the fact that it computes profits per share. When people discuss a company’s financial position, they are talking about whether it has a positive or negative net income. It is also known as the bottom line.
How to Calculate Net Income?
Net income displays the difference between revenues and expenses. It may include labor costs, depreciation costs, marketing costs, tax obligations, operating costs, and the cost of producing goods.
To determine the company’s earnings, deduct operational and spending costs from total revenue. And last, deduct tax from this sum.
You can use the following equation to determine net income:
Net Income = Revenue – Cost of Items Sold – Expenses
In other words, the net income formula is as follows:
Net Income = Gross Income – Expenses
Alternatively, if you want to make things even simpler, you can state the net income calculation as follows:
Net Income = Total Revenues – Total Expenses.
There are two possible outcomes for net income. Your business has a positive net income when revenues exceed expenses. On the other hand, you have a negative net income, also known as net loss, if all of your expenses exceed all of your revenues. NI, like other accounting measures, is susceptible to manipulation through aggressive revenue recognition or hiding expenses.
How to Calculate Retained Earnings?
The RE formula looks like this:
RE = Prior Period Balance + Net Income/Loss – Dividends (cash and stock)
Retained profits are shown on the balance sheet at the end of each accounting period as the total income from the prior year minus shareholder’s dividends. The RE ending balance from the previous accounting period will become the RE prior period balance in the next accounting cycle.
Moreover, you should consider the net income from the income statement for the current period. If your business does not have any shareholders, you don’t have to input the amount for dividends. And in case you are calculating RE for the first time, then the beginning balance will be zero.
Are Retained Earnings and Net Income the Same?
If we compare retained earnings vs net income, they do have a connection, but they are not the same. The role of NI in the business is to assess the profits. If we talk about retained earnings, it aids in comprehending both surpluses and long-term growth. Sometimes a business will have a positive net income, but it may have a negative RE. In businesses, it is known as the accumulated deficit. If the business has positive RE, it is beneficial to invest in it.
So, for example, if the revenue of the business is $80,000, and its expenses are $20,000, then the company’s net income is $60,000. Moreover, the business pays $15,000 as dividends. The retained earnings computation would be as follows:
RE = Prior Period Balance + Net Income/Loss – Dividends (cash and stock)
RE = 0 + 60,000 – 15,000
= $45,000
Retained Earnings vs. Net Income – Core Differences
- Retained earnings and net income are complementary metrics. You can consider retained earnings as your company’s long-term savings account, with net income serving as a regular contribution.
- On comparing net income vs. retained earnings, the difference between a company’s total revenue and costs is its net income. The amount left over after the company subtracts its dividend obligations and liabilities from net income is known as retained earnings. Thus, while determining retained earnings, net income becomes a key factor.
- A positive net income does not necessarily translate into a positive retained profits amount. There can be situations where net income is positive, but even then, retained profits can be negative.
- The placement of net income and retained earnings within financial reporting is a crucial distinction. NI appears on the income statement, which includes all profit and loss items. On the other hand, RE appears on both owner’s equity statement and balance sheet.
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Frequently Asked Questions
Retained earnings are reserve funds available to firm management for reinvestment back into the business. Net income, on the other hand, is the difference between a company’s total revenue and expenses. Therefore, NI is an essential part of RE computations, and both are different.
After expenses are covered, and dividends are distributed to shareholders, a company’s remaining value is known as retained earnings. In short, the amount of value that a corporation keeps as unspent net income is known as retained earnings.
The equation used for RE calculation is:
RE = Earnings in the beginning + Net Income – Dividend
Here,
Net Income = Difference between total expenses and entire revenue.
Dividend = stock value, cash value, or a combination of the two values.
Surplus earnings and net income are significant components of financial statements since they indicate the financial health of a business. When combined with a company’s debt and relevant market trends, earnings indicate how well a company is functioning and how it will progress in the future.
I am Billie wilson, a financial analyst who loves to share knowledge. I believe that everyone deserves the opportunity to succeed and so I guide people in their journey to financial growth
