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Retained profit is money that your business has earned after you’ve taken costs and other payments into account. It’s money you can put back into your business, or use to pay off business debts.
The definition of retained profit is the profit a business makes that doesn’t need to be paid out as dividends. Retained profits are also known as retained earnings.
Large companies will often pay out a portion of profits (a dividend) to owners and shareholders. Smaller companies may also pay out dividends.
Retained profit goes on your balance sheet in the equity section.
But does retained profit mean anything for small businesses and sole traders that don’t pay out dividends?
In short, yes. Retained profit is an important concept even for these businesses, as it helps them work out how much profit they can use to finance the business.
If you keep profits in the business, it can mean you don’t have to look for other types of financing, like bank loans or grants.
It can help to think of retained profit in other terms too, for example your business’s earnings surplus or trading profits.
As part of the balance sheet, retained profit helps you understand the health of your business. It goes in the equity section, which you add up with liabilities to equal (or balance with) the total of your business assets.
As mentioned, retained profit goes on your balance sheet. It builds up over accounting periods, with the net income or loss from a particular period changing the overall figure.
This means it’s not a great indicator of your business’s current success, as it doesn’t show its cash flow position or bank balance.
But as mentioned, it’s an important measure of your business’s overall health. Retained profit can help you decide whether to invest in its growth, and it can attract investors too.
Wondering how to calculate retained earnings? When doing your balance sheet, you can use this formula:
Retained profit = opening retained profit + net income or loss - dividends
So you need to know your retained profit from the last accounting period, the net income or loss you made for the current one, and any dividends you want to take (or pay out).
Having retained profits usually means that your business is in a good position, so there are plenty of advantages to keeping (and reinvesting) money in your business.
Yet there are some downsides too, which we go into here.
Would you like to know more about retained profit? Let us know in the comments below.
Sam has more than 10 years of experience in writing for financial services. He specialises in illuminating complicated topics, from IR35 to ISAs, and identifying emerging trends that audiences want to know about. Sam spent five years at Simply Business, where he was Senior Copywriter.
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