Retained Earnings in Sage 50 (Financial Statement)

Generally Working on your accounts and not being sure what is meant by retained earnings are and what they mean for your business can be quite challenging. In this article, we will try to highlight what is meant by the term (Retained Earnings in Sage 50), why retained earnings are important and how to calculate them.

What are Retained Earnings?

Retained earnings are basically the profit that a business generates. However this is only after the costs have been accounted for. These costs include salaries or production, and once any dividends have been paid out to owners or shareholders. These are sometimes termed as retained trading profits or earnings surplus. These phrases assist in further explaining what they are. Within the balance sheet these are considered to be a form of equity, which is a measure of what the business is worth. What you do with retained earnings can also imply the difference between business success and failure – especially if your business is trying to grow.

Read More : How to Fix Sage 50 Balance Sheet Out of Balance

Why Retained Earnings are Important for a Small Business

Where retained earnings offer vitality is that the business owners can also select to place it back into the business, or to pay-off the balance sheet debts.

Generally, the retained earnings can help finance the business so that you can perform new things with no requirements to go through an application process for, say, a loan, and with the cash instantly available and with no questions asked either.

As observed in this version, it has been said that the retained earnings are de facto,which is the most widely used form of business financing.

In case your business is small or still emerging, it might appear that using the retained earnings in this manner can make complete sense and you will be quite right.

In fact, there are some very small businesses, such as sole traders , who might not even account for retained earnings and instead might simply consider it as a part of working capital.

However it is important to record the retained earnings within your accounting, for plenty of reasons.

For example, you might wish to create a retained earnings account inorder to save up for some new equipment or a vehicle, which is also known as capital expenditure. Also there are other various reasons to take the retained earnings quite seriously, as explained below.

How do Retained Earnings affect a Small Business’ Financial Statements?

Most businesses include retained earnings in the form of the entry on their balance sheet. This figure is displayed alongside other forms of equity, such as the owner’s capital. Nevertheless it is quite different from this conceptually as it is considered to be earned instead of being invested.

Retained earnings are also cumulative within the balance sheet. The figure from the end of one accounting period is transferred to the start of the next, with the current net income period or loss added or subtracted. Because of this, the retained earnings figure does not necessarily communicate much about the success of the business in the here and now.

However it is considered a very good general indicator of business health and is definitely something investors observe quite closely.

Also the Retained earnings do not appear within the income statement or the profit and loss statement.

The income statement will list a net income figure that might appear to be the same as retained earnings , however it is not. The net income further contributes to retained earnings but, as mentioned, the retained earnings are cumulative across accounting periods, and are subject to dividends being taken out, and accounted for like an asset.

So, you see the forecast statement can also include the retained earnings if this is something you would  like to project to measure the growth of the company along with the sales.

This might be the requirement if you wish to attract investment, for example, because it is a useful indicator of profitability across financial periods and also in being able to show the business equity.

How to Account for Retained Earnings

To start with, do not make the mistake of believing that the retained earnings are the same as the bank balance of the business.

Essentially the bank balance will rise and fall with the business’ cash flow situation such as the received payments and spending. However the retained earnings can only be affected by the net income/loss figure of the current period.

Likewise, bear in mind that the retained earnings are not the same as the cash asset figure. Lastly Never forget that the retained earnings is basically an equity, hence it should not be displayed anywhere within the assets and liabilities parts of the balance sheet.

Are Retained Earnings the same as Reserves?

In order to understand this, you need to know that the reserve account is generally drawn from within the retained earnings. However the main difference is that the reserves have a defined purpose , for example, to be able to pay down an anticipated future debt.

So, you see, the Reserves will be displayed within the liabilities section of the balance sheet, while the retained earnings will appear within the equity section. Likewise it is also possible to create a retained earnings statement, along with the regular balance sheet and income statement/profit and loss.

This is what helps the investors in particular to get a snapshot view of the profitability of your business. Generally, the retained earnings statement is quite simple and displays the calculations as shown below in the next section.

How to Calculate Retained Earnings

To be able to Calculate the retained earnings within the balance sheet is quite simple. For this you can make use of a basic accounting formula:

Retained earnings = opening retained earnings + net income/loss – dividends

In this, let us take a look at this in further detail inorder to see what affects the retained earnings account. This is assuming that you are creating a balance sheet for the current accounting period.

In this case  we will take a look into how to calculate retained earnings for the end of the third quarter (Q3) in a fictitious business.

• Look at the Balance Sheet

For this we start by looking at the Q2 balance sheet. You will require the final retained earnings figure from this.

For example let us state that it is £10,000. In case your business is brand new then the starting retained earnings figure will be £0.

Let us assume that your business is not new. In this case you will need to deduct from the retained earnings figure any dividends that you wish to pay from Q2 to yourself, other owners of the business, or even the shareholders.

Let us  say that you decide to take £3,000 as a dividend. In this case, your retained earnings figure will now be £7,000.

Add the retained earnings figure of £7,000 over to the Q3 balance sheet within the retained earnings section under the equity section.

Lastly, add the current net income/earnings figure, that have been listed within the Q3 income statement/profit and loss, over to the retained earnings figure for Q3.

In case you are using a spreadsheet, you will need to create a formula that automatically does this.

To carry the above stated example, in case your income statement/profit and loss shows net income as £5,000 for Q3, then the closing retained earnings figure on the balance sheet for the Q3 period is £12,000; that is, £7,000 + £5,000 = £12,000.

Also Read : Chart of Accounts in Sage 50

Final Though

Lastly stating, the Retained earnings is one of those financial matters that may not appear to be important for smaller or newer businesses.

However it is quite important to at least gain an understanding of what it means, even if you are not directly accounting for it yet; for example, in case your business accounting does not really get much beyond a profit and loss statement.

Knowing and understanding your retained earnings figure can help with business growth.

However , more than this, those who wish to invest in your business will expect you to understand the importance as they are going to be investing not only in your business but also in you. Finally if you are  taking care of your basic accounting, then it could be viewed as a sign of a well-run business.

Frequently Asked Questions (FAQs)