The amount of net income, after dividends have been paid to shareholders, that is retained by the company to be reinvested in its core business.
Net income is the amount of money a business has earned after paying its expenses. Once that net income is calculated, the top financial priority of a corporation is to pay its shareholders. Anything left over from paying shareholders can be reinvested into the business to fund growth, and that leftover amount is known as retained earnings.
As a concept, retained earnings only refers net income (after dividend payments) that has been reinvested in the business. Companies could use the remaining money to pay their shareholders more or give bonuses to executives. However, doing so takes that money out of the company’s coffers, meaning that it has not been retained.
When a company chooses to reinvest its earnings surplus, it can do so in many different ways, including expanding business operations or product offerings, engaging in share buybacks, funding mergers and acquisitions or paying down business debt.
Over time, analysts can look at retained earnings to assess a company’s financial health and commitment to growth. When a company has a consistent earnings surplus and uses it to reinvest in the business itself, that can be seen as a sign of long-term commitment to success.
After a great year of sales, an electronics manufacturer enjoys a significant earnings surplus. Upon paying out basic dividends to its shareholders, it proposes to using retained earnings to fund research and development of a new product line. The shareholders vote on the proposal and approve.