Retained profit/retained earnings

Retained profit, or retained earnings, may appear on the balance sheet or the profit and loss account. It is the amount of profit kept by the company rather than paid as dividends.

P & L retained profit

On the profit an loss account, the retained profit is the profit that is left in a company after paying out dividends: post tax profit less dividends paid.

The amount of retained profit clearly depends on the the dividend policy. A high dividend payout is usually taken as an indication of confidence.

Balance sheet retained profit.

Retained profit on the balance sheet is the accumulated retained profit. In each accounting period it is increased by the P & L retained profit for that period.

Retained profit on the balance sheet is significant because dividends must be paid out of distributable reserves, this means that a low accumulated retained profit limits dividend payments. This is why scrip issues are taken to be signs of confidence: management are signalling that there is no danger that reducing distributable reserves will make a dividend cut necessary. There is plenty of money to pay dividends.

A paradoxically different inference is that high distributable reserves are a sign of financial stability: high retained earnings are an indicator of a history of profitability. For this reason, balance sheet retained earnings is a factor in the Altman Z-score.

The problem with any use of the balance sheet retained profit is that it can be changed by corporate actions and reorganisations.

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