Retained earnings are part of the company’s net income which is retained by the company and not paid as dividends to shareholders. This money is usually reinvested into the company, so that it becomes the main ‘fuel’ for the company’s continued growth, or is used to pay off the company’s debts.
This profit will be accumulated and reported as owner’s equity in the balance sheet. The amount of retained earnings is usually determined by the policy of the board of commissioners of a company which will certainly differ between policies in one company with other companies. Benefits of retained earnings in the accounting process itself namely:
- To finance the company’s operations in achieving maximum profit.
- To pay off existing debt.
- As a reserve fund for the company’s investment needs.
- For the development of the company in the future.
How to Calculate Company Retained Earnings
Here’s how to calculate retained earnings in a company:
1. Collect the Required Data from the Company’s Financial Statements
Every company is required to formally document the company’s financial history. If you can do this, it’s usually easier to calculate retained earnings for the current period by using numbers from official reports to find out the amount of retained earnings on a certain date, net income, and dividends already paid, compared to if you have to calculate them manually . The company’s retained earnings until the last recording period will be displayed in the balance sheet, while the company’s net income will be displayed in the income statement for the current period.
If you can get all this information, you can calculate retained earnings using the following formula:
Net profit – dividends paid = retained earnings
Next, to calculate the cumulative net income, add the retained earnings number that you just calculated with the current retained earnings balance at this time.
For example, for example at the end of 2011 your business had a cumulative retained earnings balance of Rp.512 million. During 2012, your business generated a net profit of IDR21.5 million and paid a dividend of IDR5.5 million. The final balance of retained earnings from your business is:
Rp21.5 million – Rp.5.5 million = Rp16 million
Rp.512 million + Rp16 million = Rp528 million
So, your business already has a retained profit of Rp. 528 million.
2. If You Don’t Have Net Profit Information, Start by Calculating Gross Profit
If you cannot access the net profit value for sure, you can calculate the net profit of a business by manually counting through a slightly longer process. Start by calculating the company’s gross profit. Gross profit is a number generated from the income statement and is calculated by subtracting the money from the sale with the cost of goods sold.
For example, suppose a company managed to reach a sales figure of Rp150,000 in one quarter, but had to pay Rp90,000 for goods needed to produce a sales figure of Rp150,000. Gross profit for the quarter is,
Rp150,000 – Rp90,000 = Rp60,000
3. Calculate Operating Profit
Operating profit reflects the profit of the company after paying sales costs and operating costs, such as wages already paid. To calculate this operating profit, subtract gross profit by the company’s operating costs (not including cost of goods sold).
For example, in the same quarter where our business generated a gross profit of Rp. 60,000, there were payments for administrative costs and wages of Rp. 15,000. Thus the company’s operating profit will be,
R p60,000 – Rp15,000 = Rp45,000.
4. Calculate Net Income Before Tax
To calculate net income before tax, subtract the company’s operating profit by interest, depreciation, and amortization. Depreciation and amortization are depreciation of the value of assets (tangible and intangible) during their economic life. This is recorded as an expense in the income statement. If a company buys equipment at a price of Rp10,000 with an economic life of 10 years, a depreciation fee of Rp1,000 per year will occur, assuming the value is evenly depreciated.
For example, our company pays an interest fee of Rp1,200 and a depreciation fee of Rp4,000. Net income before tax from our company will be
Rp45,000 – Rp1,200 – Rp4,000 = Rp39,800.
5. Calculate Net Profit After Tax
The last cost we have to calculate is tax. To calculate net income after tax, first of all, calculate the company’s tax rate with net income before tax. Next, to calculate net income after tax, subtract this multiplication result from the net profit before tax.
In the example we discussed, we assume that the tax rate is 34%. The tax fee that we have to pay is equal to,
34% (0.34) x Rp39,800 = Rp13,532.
Next, we subtract this number from the net profit before tax as follows.
Rp.39,800 – Rp.13,532 = Rp.26,268.
6. Reduce the Dividend Amount Paid
After we calculate the size of the company’s net profit after deducting all costs that are our obligation, we have a number that we can use to calculate the amount of retained earnings during the accounting period that runs. To calculate this, subtract the net profit after tax with the dividends already paid.
In the example we discussed, we assume that we paid dividends to investors of Rp 10,000 for this quarter. Retained earnings for this current period will be,
Rp26,268 – Rp10,000 = Rp16,268.
7. Calculate the Final Balance of the Retained Earnings Account
Don’t forget that retained earnings are a cumulative account that shows the net change in retained earnings since the establishment of the company until now. To find out the total retained earnings, add retained earnings from the current period with the ending retained earnings at the end of the bookkeeping period.
We assume that our company has retained a profit of 30,000 to date. Now the balance on our retained earnings account will be,
Rp.30,000 + Rp.16,268 = Rp. 46,268
Calculation of retained earnings is of course different in each company. This is due to differences in the amount of dividends agreed by the commissioners or differences in the type of company. When all of the above calculations have been fulfilled, then the remaining retained earnings can return to the company as an investment for the next quarter. But it can also be retained earnings allocated to other things in accordance with the agreement of the company commissioner. Retained earnings are also possible to have a minus value because the company suffered losses compared to the previous year. Because losses are greater than the total of all retained earnings, this allows the total retained earnings to be minus.
