Retained Earnings

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Definition of 'Retained Earnings'

Retained earnings are the portion of a company's net income that is not distributed to shareholders as dividends. Instead, it is reinvested in the business to fund future growth or operations. Retained earnings can be used to purchase new assets, invest in research and development, or simply to increase the company's cash reserves.

Retained earnings are an important source of financing for businesses, as they provide a way to fund growth without having to borrow money from banks or other lenders. Retained earnings can also help a company to weather economic downturns, as they can be used to cover operating expenses during periods of low sales.

The amount of retained earnings a company has is determined by its net income and its dividend policy. Net income is the amount of money a company has left after paying all of its expenses and taxes. Dividend policy refers to the company's decision of how much of its net income to distribute to shareholders as dividends and how much to retain for future use.

Companies with high levels of retained earnings are often seen as being more financially stable than companies with low levels of retained earnings. This is because retained earnings provide a cushion against unexpected expenses and can help a company to weather economic downturns.

However, it is important to note that retaining too much earnings can also be a problem. This is because retained earnings are not taxed, so companies that retain too much earnings may be missing out on potential tax savings. Additionally, retained earnings can be a source of conflict between shareholders and management. Shareholders may want to see their dividends increased, while management may want to retain earnings to fund future growth.

Ultimately, the decision of how much to retain and how much to distribute as dividends is a complex one that must be made on a case-by-case basis. There is no one-size-fits-all answer to the question of how much retained earnings a company should have.

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