Having some funds to keep back- Retained earnings (REs) is one of the primary features of a successful business. Small businesses that are still growing need to have some funds in reserve for reinvestment so that the business continues to progress. Usually, some people choose to regard retained earnings as retained trading profits or earnings surplus because of how the money is realized.
Furthermore, these extra profits on a balance sheet represent a form of equity and show the worth of a business. As a result, the way a business, especially a small business manages its retained earnings makes a difference regarding its success and failure. Therefore, if you are a small business owner, in this blog post, you will discover what REs are and how accountants can help you make the most of it.
In the financial management of small firms, retained earnings are quite important. The fraction of profits that are put back into the business as opposed to being given to shareholders is represented by these earnings. Retained earnings are a great source of financing for small firms that may be applied to a variety of projects. In this post, we’ll look at how small firms might use retained earnings to support long-term sustainability and growth.
What are retained earnings?
They are the earnings surplus that any business decides to keep after all other deductions, expenses, and dividends are paid to stakeholders. Essentially, the idea behind REs is for reinvesting into the business. Little wonder they are vital for small businesses that are still on their way to the top.
How small businesses use retained earnings
Besides, the general reinvesting into the business and occasionally paying off debts, there are other uses of retained earnings. Here are a few of them.
For business expansion
Business expansion is the primary utility of REs. Essentially, most businesses reinvest the extra funds into a couple of projects like a new line of business, a building project, upgrading existing infrastructure, acquiring new equipment, or hiring more staff to increase their workforce.
Business Expansion and Growth: One of the main purposes for which small firms employ retained earnings is to finance these endeavors. Retained revenues offer the money for these activities, whether they be expanding into new areas, funding R&D, or improving infrastructure. Small firms can benefit from chances to broaden their market presence, boost their capacity for production, and create new goods or services by reinvesting their revenues.
To launch a new product into the market
Often, companies, especially growing ones, need lots of funds to enable them to launch a new product into the market. The reason is that they have to cater to ads, and survive the market competition to drive their new product. This is pretty essential when a company needs to unfold a new product. A critical move to expanding their existing product line. Launching a new product is a great way to introduce a complementary product into the market to drive company sales. For example, a bread-making company might decide to launch cookies into the market or milkshakes and so on. That way, the company can boost its competitive advantage and value long-term.
Retained revenues can also be utilized by small enterprises to pay off obligations that already exist. Businesses can strengthen their financial position, save interest costs, and increase their creditworthiness by reducing their debt loads. Small firms can improve their balance sheets and lay a strong basis for future growth by repaying debts with REs.
To pay company dividends
Company surplus funds are perfect for paying dividends to shareholders of the company. However, this payment is at the discretion of the company in general. Additionally, the shareholders reserve the right to influence the utility of the funds in this regard since they form majority ownership of the company.
Effective working capital and wealth management is essential for the efficient operation of any business. Retained earnings can be utilized to maintain proper working capital levels, ensuring that the company has enough money to pay for ongoing costs, control inventories, and fulfill immediate obligations. Retained earnings can help small businesses manage their working capital, preventing liquidity problems and preserving their financial stability.
To strike a merger or acquisition
When a smaller business wants to grow stronger, it often considers merging with another business. Similarly, when an existing business wants to increase dominance, it considers acquiring a weaker or smaller business. Whether it is acquisition or merging, both processes require funding. As a result, the surplus funds from retained earnings are what facilitate either business move.
To increase operational effectiveness and productivity, small firms frequently need to invest in new machinery, infrastructure, or technology. Businesses can upgrade their operations and maintain market competitiveness by allocating retained earnings toward buying or upgrading assets. Small firms can simplify their operations, reduce costs, and grow by making investments in assets.
Research and Development (R&D):
Investing in R&D is crucial for promoting innovation, which is crucial for the success of small firms. Retained earnings can be used to fund R&D projects, allowing small enterprises to create new goods, enhance old ones, and maintain a competitive edge. Small businesses can promote innovation, draw in new clients, and develop a long-lasting competitive advantage by using retained earnings for R&D.
Dividend Payments:
Although retained earnings are typically reinvested by small enterprises, dividend payments to shareholders are one option. Dividend payments acknowledge shareholders for their financial support of the business and may entice additional capital. Small enterprises must, however, balance returning profits to shareholders with holding on to them for future expansion.
Emergency funds and contingency planning:
Emergencies and unforeseen occurrences can be very difficult for small enterprises. To cover unforeseen costs, economic crisis, or other emergencies, retained earnings might be placed aside. Small firms can navigate through trying times without endangering their long-term existence by creating backup plans and accumulating reserves.
Organizing a statement for retained earnings
Calculating REs can seem pretty challenging especially if manipulating account information is not your thing. As a small business owner, while you can try gaining reasonable knowledge of how retained earnings work; accountants help take the edge off. Here is how they can help.
How accountants can help with retained earnings
A statement for RE gives a general rundown of changes in a company’s surplus earnings for a particular accounting cycle. Essentially, the statement for RE is structured as an equation in such a way that it opens with the retained earnings placed at the beginning of the reporting period. Next up is to adjust net income, dividends, etc. After that, the closing cycle for that particular accounting cycle forms the opening balance for the next accounting cycle.
As a small business owner, your accountant sifts through all financial documents to ensure that they are in order. Also, if you have any workers, your accountant will have to generate and issue a w-2 form to your workers as well as curate other forms like 1099, if you have received any non salary income. That way, you can easily get all withholdings out of the way so that all you have is for further planning. Essentially, the statement for retained earnings is for attracting and keeping potential investors and other external parties.
The statement for REs that your account will prepare can either be a stand-alone document or attached to another financial statement like a balance sheet or income statement. Usually, accountants in the United States like to follow the (GAAP) Generally Accepted Accounting Principles. Although you can decide to prepare your statement on a monthly, quarterly, or annual basis.
Final Thought
Although most small businesses, especially those who have not grown beyond the profit and loss stage might not have much to do with calculating retained earnings. However, the knowledge is relevant for every business owner who aspires towards growth and expansion.
Additionally, knowledge of retained earnings will help the small business owner with striking deals with investors. It will show potential investors that the entrepreneur has optimum business operations and management skills.
In summary, retained earnings give small firms a vital source of funding to support their expansion and guarantee long-term viability. Small firms might use REs for a variety of things, including financing company growth, paying off debt, managing working capital, investing in assets, fostering innovation through R&D, paying dividends, or setting up emergency savings. For small firms to achieve their financial objectives, balance the needs of shareholders and the company, and maintain a solid financial position in a cutthroat business environment, effective management of REs is essential.
FAQS:
How do Businesses use retained earnings?
Generally, businesses use retained earnings to finance the business through reinvestment. Other times, they can have a new product line to the frontier, or pay back a loan. However, any business with healthy finances will balance paying dividends to shareholders and financing the growth of the business.
What retained earnings are for small businesses?
For small businesses and pretty much other businesses, REs are the profit generated from a business after production costs, and other deductions like stakeholder’s dividends are paid. Sometimes, they are called retained trading profits or earning surplus because of how they are realized.
Can a company spend its retained earnings?
Because retained earnings are liquid assets, a company can spend them. However, it is always better to spend a company’s REs by reinvesting them into the business. For instance, in purchasing assets to help the company grow and expand.
