In short, retained earnings are the cumulative total of earnings that have yet to be paid to shareholders. These funds are also held in reserve to reinvest back into the company through purchases of fixed assets or to pay down debt. It’s not always good news for investors when companies pay dividends out of retained earnings. Some investors are less concerned with distribution and more interested in stock appreciation. If you’re such an investor, you don’t want your company paying out dividends as it ads to a tax burden and slows company growth. Profitable companies are more likely to pay dividends than those closing the accounting period on a deficit.

As an important concept in accounting, the word “retained” captures the fact that because those earnings were not paid out to shareholders as dividends, they were instead retained by the company. They make up the total equity a company received from its shareholders in exchange for issued shares, also known as contributed capital. There are also some rules and regulations that companies must follow when it comes to paid-in and additional paid-in capital balances. Given this crucial role, it’s easy to wonder why companies may choose to pay dividends. Most commonly, companies pay dividends to incentivize investors to continue holding stock.

What Effect Does Declaring a Cash Dividend Have on Stockholders’ Equity?

Traders who look for short-term gains may also prefer dividend payments that offer instant gains. What retained earnings are Retained earnings represent the accumulated earnings from a company since its formation. Most companies lose money when they first start up, and so for a time, their retained earnings will be negative. That’s one reason why most start-ups don’t pay dividends, in addition to the fact that new companies generally need to hold onto any cash they have to grow their business. Revenue, sometimes referred to as gross sales, affects retained earnings since any increases in revenue through sales and investments boost profits or net income.

two-for-one split doubles the number of shares outstanding, a three-for-one split
triples the number of shares, and so on. The split reduces the par value per share at
the same time so that the total dollar amount credited to Common Stock remains the
same. If the
corporation issues 100 percent more stock without a reduction in the par value per
share, the transaction is a 100 percent stock dividend rather than a two-for-one stock
split. When a company issues a stock dividend, it distributes additional quantities of stock to existing shareholders according to the number of shares they already own. Dividends impact the shareholders’ equity section of the corporate balance sheet—the retained earnings, in particular. Assume ABC issues a stock dividend to common stockholders, resulting in a total issuance of 10,000 additional shares.

  • If so, the company would be more profitable and the
    shareholders would be rewarded with a higher stock price in the
  • A company profits, distributes some of them to shareholders as dividends, and keeps the rest as retained earnings to be reinvested.
  • DPS can be calculated by subtracting the special dividends from the sum of all dividends over one year and dividing this figure by the outstanding shares.
  • Stock dividends do not have the same effect on stockholder equity as cash dividends.
  • Retained earnings represent a useful link between the income statement and the balance sheet, as they are recorded under shareholders’ equity, which connects the two statements.
  • Auditors are required by
    this law to become more aggressive in looking for fraud in companies
    they audit.

If the company is wrapping up its operations, then it can make dissolution or liquidation dividend payments to shareholders regardless of the condition of its balance sheet. Of course, just because a company can pay dividends doesn’t mean it always will. The company won’t always have actual cash to pay a dividend, even if the retained earnings line item on its balance sheet is positive. Still, some companies will borrow money specifically to pay a dividend during times of financial stress. Retained earnings are the portion of a company’s net income that management retains for internal operations instead of paying it to shareholders in the form of dividends.

Retained Earnings Example

It can most easily be thought of as a company’s total assets minus its total liabilities. In the long run, such initiatives may lead to better returns for the company shareholders instead of those gained from dividend payouts. Paying off high-interest debt also may be preferred by both management and shareholders, instead of dividend payments. Profits give a lot of room to the business owner(s) or the company management to use the surplus money earned. This profit is often paid out to shareholders, but it can also be reinvested back into the company for growth purposes. Once a company starts making money, then its retained earnings start to rise.

Understanding Dividends: Price Implications

After the ex-dividend date, the share price of a stock usually drops by the amount of the dividend. Sometimes, especially in the case of a special, large dividend, part of the dividend is declared by the company to be a return of capital. The net effect of the stock dividend is simply an increase in the paid-in capital sub-account and a reduction of retained earnings. Though uncommon, it is possible for a company to have a negative stockholder equity value if its liabilities outweigh its assets. Because stockholder equity reflects the difference between assets and liabilities, analysts and investors scrutinize companies’ balance sheets to assess their financial health. If a company decides to issue a cash dividend to its shareholders, the funds are deducted from its retained earnings, and there is no effect on the additional paid-in capital.


However, it is more difficult to interpret a company with high retained earnings. For example, during the period from September 2016 through September 2020, Apple Inc.’s (AAPL) stock price rose from around $28 to around $112 per share. During the same period, the total earnings per share (EPS) was $13.61, while the total dividend paid out by the company was $3.38 per share. Dividend stocks are some of the best and most important stocks in your portfolio. Not only do they offer you some impressive capital gains potential as all equities do, but they are also usually stable businesses and can provide attractive passive income to investors. Yes, retained earnings carry over to the next year if they have not been used up by the company from paying down debt or investing back in the company.

But, the best way to prove profitability is by looking at the income statement; and not how many times the company has paid dividends in the past. When a company’s stock profits, its board of directors may choose to pay out those profits in the form of a dividend. The board can also decide against paying out dividends because corporations aren’t necessarily required to pay out dividends. By the time a company’s financial statements have been released, the dividend is already paid, and the decrease in retained earnings and cash are already recorded. In other words, investors will not see the liability account entries in the dividend payable account. After the dividends are paid, the dividend payable is reversed and is no longer present on the liability side of the balance sheet.

Note, however, that the purchase date does not count toward the 60-day total. For shareholders, dividends are considered assets because they add value to an investor’s portfolio, increasing their net worth. For a company, dividends are considered a liability before they are paid out.

Retained earnings are the portion of income that a business keeps for internal operations rather than paying out to shareholders as dividends. Retained earnings are directly impacted by the same items that impact net income. These include revenues, cost of goods sold, operating expenses, and depreciation. Additional paid-in capital is included in shareholder equity and can arise from issuing either preferred stock or common stock. The amount of additional paid-in capital is determined solely by the number of shares a company sells. If your business currently pays shareholder dividends, you simply need to subtract them from your net income.

Corporations: Paid-in Capital, Retained Earnings, Dividends, and Treasury Stock

It is the lowest cost finance that a company can use since the company generates it internally. However, retained earnings may be finite depending on the resources and performance of the company. While additional paid-in capital balance represents a different amount and balance than the paid-in capital balance of a company, both of them are very closely related.